Knowles Corp (KN) 2022 Q4 法說會逐字稿

Good afternoon, and welcome to the Knowles Corporation Fourth Quarter and Full Year 2022 Financial Results Conference Call. My name is Tamiya, 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, Tamiya, 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 Niew, 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 Knowles, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal securities law. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company's sales, expenses and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings, including, but not limited to, the Annual Report on Form 10-K for the fiscal year ended December 31, 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 Knowles disclaims any duty to update such statements, except as required by law. In addition to pursuing 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 knowles.com, and in our current report on Form 8-K 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 operations 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 into 2 -- in segment in 2. The first segment is called MedTech & 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 microphone sold into the ear, IoT, compute and smartphone markets. Knowles now operates and reports under 3 segments: Precision Devices, MedTech & Specialty Audio and Consumer MEMS Microphones. With that, let me begin with a summary of our Q4 results.

We are 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 end market demand and customers' inventory adjustments in Consumer MEMS and Medtech & Specialty Audio.

Consumer MEMS Mics was down 31% versus prior year levels, and Medtech & 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, medtech, EV and industrial end markets. We delivered gross margins of 40.4% above the high end of our guided range, earnings per share of $0.33, in line with the guidance -- with our guidance, and we generate just shy of $40 million of free cash flow, which was at the high end of our expectation. I believe these results that 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, medtech 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 & Specialty Audio segment delivered record gross margins and adjusted EBIT in the year. Revenue was flat with prior year levels, had 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 increase over prior year levels. Adjusted EBIT finished at $88 million, a 10% increase versus 2021. Although market conditions deteriorated slightly for the segment, 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 demand. 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 Q2 '23 as customers' inventories normalize.

Now on to our Consumer MEMS Microphone business, revenue in this segment was down $144 million versus prior year level. 2022 was a difficult year for consumer electronics around the gold as end market demand, customer inventory adjustments and the impact of COVID lockdowns in China severely impacted the segment's topline. 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 demand, we will continue to operate in 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 customer -- our customers' new products.

In summary, for the company, Q1 is normally sequentially lower due to seasonality, but is 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 3 segments contributing.

Lastly, I would like to highlight we have secured an extension of our $400 million revolving credit 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 & 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 & 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 & 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 Microphones 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 spin-off, 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 USD140 million and USD155 million, down 27% versus the same period a year ago, with the decline in revenues driven by weak demand in Consumer MEMS Mic, inventory corrections in MedTech & 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 ago period, driven by low factory capacity utilization and unfavorable mix in our Consumer MEMS Mic and MedTech & Specialty Audio segments.

R&D expense is expected to be between USD16 million and USD18 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 and administrative expense to be between USD25 million and USD27 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 USD0.01 to USD0.07 per share. This assumes weighted average shares outstanding during the 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 our tax holiday in Malaysia.

For the quarter, we expect cash generated from operations to range between USD15 million and USD25 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 3 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?

Thanks, John. While 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 a 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% EBITDA margins and 15% to 17% free cash flow margins.

With that, we can open up for questions.

(Operator Instructions) Our first question comes from Bob Labick with CJS Securities.

So I just wanted to kind of dig in a little more on what you just gave us in terms of guidance and a look into 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% in -- plus or minus in Q1, 10% in 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 segments orientation that you've laid out for us?

Yes, Bob. I'm happy to do that to 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 full year. But let me start with Q2. Let me break this up by the business unit. 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 & 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 normal 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 I think when we think about the sequential growth improvement in Q2, I think, we're pretty happy about where we are with that.

In the PD space, I would say it's kind of a similar story. The current bookings, which are even longer than -- out than where we would be in the MedTech & Specialty Audio are pretty good and the expectations to see growth in defense, EV, medtech are quite good. So I think we feel pretty good about that as well. And lastly, in the Consumer MEMS 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. I mean, right now, if I were to sit there and look at my forecast or how I look at China. China is 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 pipes. And I would point out specifically compute. We're not seeing a real recovery or move out of the inventory until probably that's the back half of the year. So 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 PD. 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. And that's being driven by the kind of 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 become 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 the 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 the top -- first quarter already being down versus prior year, it's probably going to get -- be tough to get more than a flattish 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 MEMS Microphone business. I mean there's a lot of people were 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, the first half continue 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 it's a long answer. But all in all, I guess what I would say, given the PD up mid-single digits, MSA relatively flat. And given the first half challenges with CMM and I would say, 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 want to make sure we cover that.

Yes, that's super helpful. And then it doesn't sound like this is the case at all, but I just want to clarify. In terms of some of the changes, is there any market share shifts of any -- now 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?

Yes, 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 going to be a shift. I would sit there and say, we're taking share in the defense portion of that market and EV is the new market. So I don't know how you sit there -- and they were taking share. We're just capitalizing on a new market in terms of EV. In Medtech & Specialty Audio, I could 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 MEMS business, I really can't point to and sit there and say, we've lost this or we won this, that's changing share significantly. 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 -- and really to get the improvement and if 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 set it's complete. I think you've kind of planned the capacity drawdown, so to speak, back in August or sort of 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 are you going to -- 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 we have right now. But there's a lot of background. Bob, there's been a lot of background noise on front.

Okay. I -- sorry, this is my last question. So if you can just answer I'll hit mute.

Yes, I'll answer it. I answer it. 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 as 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.

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

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 3 segments and either for shrink 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?

Yes. So for the March quarter, I would sit there and say, we talking Q4 to Q1, yes. So I would sit there and say, in Precision Devices, we typically seasonally Q1 is down. We're expecting growth in this business again in Q1 year-over-year, but it is down sequentially. And just to describe it kind of goes behind 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, we had a very strong first half of '22. It's definitely slowed down.

And if you look at some of our hearing aid customers, they're starting to report, they're basically point 1% to 3%, 1% to 4% 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. And so -- but I would -- 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 were already fully booked, which is probably a little earlier than we expect. As we go into Q2, we're already starting to see bookings that are stronger probably than -- or stronger than -- as we're kind of talking 15% to 20% sequential growth in the Q2.

So I think -- I feel pretty good about that business going into Q2 and into the back half of the year. I think the big wildcard 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. And so as I said, I'm cautiously optimistic that this business can return to growth year-over-year in the back half of '23.

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? I guess, I'm just looking at --

It's fully booked out to that lower expectation. But it's -- I would say, it's skewed towards the end of the quarter that the booking -- 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 2 things there. First of all, I'd love to understand the full industry dynamic perhaps you can quantify even how this inventory dynamic looks 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 weaker June than 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 shipment 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 with between PD and MSA, so PD and the Medtech & 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 same things, you are 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. That's helpful, Jeff.

Our next question comes from Anthony Stoss with Craig-Hallum.

Jeff, let me start with you. I wanted to really focus on 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?

So I would sit there and say that the majority of stuff we do is with the custom stuff, which is medtech, 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 bills, we deliver their custom products. We're not seeing people say, oh, I got too much inventory in that portion of the market. So if you look at the PD business, I would say the industrial/distribution business was somewhere in the neighborhood of $50 million, $60 million for -- on an annualized basis. We are definitely -- because we watch that inventory. It's 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 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 with nature of your competitors, and I know you guys have 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 are your competitors acting fairly rational at this point?

I would say, in the PD space, again, most of our stuff is custom, long-term contracts. 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/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 as we -- 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 3, 4 years. We've done a pretty good job of keeping that sub-4%, even sub-3%. But as you look at the end of this year, as we started saying, okay, we 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 we're hopeful of new products and things that will happen towards the back half of next year and into 2024 that will reverse that trend again. But in the short-term, it's kind of tough on pricing in that business. And as but on the hearing health, I think a business or MSA business, I think the dynamics really haven't changed dramatically. I think we're seeing essentially flattish pricing.

Yes. Tony, just to add -- on PD, one of the big drivers of -- one of the drivers of gross margin expansion in '22 was pricing. We increased gross margins 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. It makes sense. And then, John, since I have you, alone kind of your view on the full year CapEx, I know you gave us for Q1. And 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 on the reduced expectations for 2023, where your cash flow goes? I know in the past, you were hoping that it nearly double, but I'm curious what your updated view is for free cash flow?

I thought you led with a -- do you lead CapEx or cash -- free cash flow or both?

CapEx?

From a CapEx -- And I think -- We're going to -- yes, 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. We clearly aren't going to put in more CapEx for capacity in CMM. So I would say 2/3 of our CapEx in '23 will go to PD and MSA.

And I think, it's worth just mentioning on the CapEx side, 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?

Yes. 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 net working capital. inventory increase, our payables because we really started turning off the picket. 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 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 expense.

And that kind of points to getting back to the free cash flow percent of sales back to where we were in '21.

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

Yes. Yes, I would say, the answer to that is yes. I think let me just break it down by segments. We're expecting growth in Precision Devices in the back half -- over the back half of '22, it'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 is expecting the end market, our customers, and there's a lot of data out there are expected to return back to growth in the back half of the year. So we're expecting some nice growth year-over-year. The wildcard is really around the microphone business. I think right now, if I were to sit here and say, yes, 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, I kind of said in my -- to Bob's question, we'll end up flattish. Well, 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. Appreciate it. Best of luck.

Thank you. (Operator Instructions) Our next question comes from Suji Desilva with ROTH Capital.

Maybe hitting on a sub-segment, 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 2 to 3 years out?

Yes. I think it's -- we're kind of mentioned 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% -- 30% to 40% growth in terms of revenue so that it will be over -- probably over $20 million in revenue. But I think the other part about this, Suji, I just kind of would make the comment is, the bookings are becoming very strong. And so I mean, 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 like 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 an indication of where that business can probably go in 2024.

So all that said, design wins are strong, it depends on who are the winners, 3, 4 years from now. But I think we had said we hope this business could be like $50 million, $60 million in 3 to 4 years. I think that's achievable. And if we win with the winners, we'll see who those are in terms of how much content we have, it could be even more than math. So it's starting to become material later this year into '24.

Okay. And then my other question is for John perhaps. You talked about a lot of the elements looking ahead to in revenue, 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 -- is the -- 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?

Yes. 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 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 the corporate -- 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 have conversely the benefits from the restructuring we took. So again, I think kind of a $45 million run rate is appropriate.

Thank you. Our next question comes from Christopher Rolland with Susquehanna.

Sorry about that mute button. This one is 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 were?

Yes, Chris, I said gross margin, we'd have -- Jeff mentioned sequential growth of 15% to 20%. And I said with that, gross margins will be back at 40% or above in Q2.

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

Yes, I didn't say that. That gross margin getting back to 40% is dependent on increased capacity utilization, but we do.

There's going to be a significant improvement in EBIT margins in Q2, but not at that level --

But not at that level, yes?

The gross margins in Q1, you did in Q2, look at the revenue. That's -- most of 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 4% above, and I just gave the run rate on OpEx. So you can --

Yes. 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. (Operator Instructions) 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 lines.