Knowles Corporation (KN) Earnings Call Transcript & Summary

All right. Great. Hi, everyone. My name is Kristina Nilsson. I'm a Managing Director in JPMorgan's Technology Investment Banking team. And I'm delighted to be joined by Jeff Niew, President and CEO of Knowles and John Anderson, CFO of Knowles. Great to have you with us, Jeff and John.

Thank you.

Thanks, Kristina.

So to start us off, why don't you provide us with a quick snapshot of Knowles and in particular, how the business has evolved over the last couple of years?

Sure. I'll first refer you, we did do an investor update presentation at the end of November, and we updated our midterm model. I'll refer to that, but it is on our website. For those of you who don't know Knowles very well, we have a long legacy of being a supplier of electronic components across a very diversified set of growing end markets. We have a strong competitive position and the opportunity to win based on our engineering and our manufacturing differentiation. We believe our revenue diversity with exposure to different growth areas and markets, we've really seen the benefit over the last 3 to 4 years in our financial performance. We have 2 segments: Audio. First, Audio is primarily MEMS microphones across mobile, ear, IoT, compute. We pioneered this market 15, 20 years ago. And we like to talk about the fact that we make over 2 billion microphones a year and that we shipped 20 billion since we started -- 20 billion microphones since we've started producing this product. And we have a lot of tailwinds in the IoT, ear and compute markets with less reliant on mobile hub -- less reliance on mobile. The other portion of our audio business is our hearing health business where we're the leader in microphones and speakers for over 50 years. We see the requirements for hearing aids converging with the true wireless market, coupled with the expected introduction of over-the-counter hearing aids, which are recently going to be approved by the U.S. government to be sold, which will bring great growth opportunities for us. We've always referred to this business as a GDP-type business. But now it's actually GDP-plus. It's growing at a faster rate than it had in the past due to, again, over-the-counter hearing aids, convergence with true wireless as well as demographics where older people are starting to buy more hearing aids. Our second segment is the Precision Device segment, which has 2 pieces; high-performance capacitors. These are not capacitors that are jelly bean capacitors. These are very high-performance capacitors, focused on things like high temperature, high voltage and high reliability. Some of the areas that we sell very -- a lot into are areas like implantables, defense systems, high-voltage electric charging systems for electric vehicles. So a very, very nice market for us with very good gross margins. And then the last piece in our PD is our RF solutions group. It's our fastest-growing business through a combination of both a combination of organic growth as well as acquisitions we've done in the space. And it's primarily focused on the defense market, where we've been very successful. This business, again, is our fastest-growing business that we have. Just briefly on our financials. We've improved our growth -- our operating margins rather by over 500 basis points over the last 4 years. We've doubled our free cash flow margins over -- at the same period of time. It's been done through sales growth, operating leverage and gross margin expansion. And primarily, our gross margin expansion has been around the idea that we're selling less commoditized products, and we're shifting more of our investment, whether it be human capital, CapEx into areas where we have the highest gross margin opportunities like in defense and medtech which are growing at a very good rate. Over that period of time, just in closing from '17 to 2021, we've taken our EPS from about $0.88 to well over $1.50. We expect to see earnings growth again this year. And it has also allowed us the free cash flow to kind of like adjust our capital allocation strategy, which would be primarily focused on paying down debt. We're now net debt 0. We have been buying back shares as well as doing accretive acquisitions, 5 since 2017. And so, overall, we just recently announced a new $150 million stock buyback, where we actually committed 50% of our free cash flow will be going back toward that stock buyback. So just in closing, we're targeting operating margins of 22% to 24%. Free cash flow margins of 15% to 17%. This kind of equates that we're a little over $1.50 of EPS last year that in the midterm, we think we can get to over $2.50 of EPS. Pretty exciting time. The financials look very good. And I think a lot of the work we've done over the last 4 or 5 years is really starting to pay off in the financials.

Terrific. Thanks, Jeff. So why don't we dive into some of the additional financials. So you've delivered some impressive improvement in mix the last couple of quarters, which has had a positive impact on gross margins. How much of that is structural versus opportunistic given the tight supply chain?

I would say almost all of it is structural. And the way I describe this is, if you go back in our business and think of our commodity businesses, primarily to mobile, 4, 5 years ago, about 30%, 35% of our business came from mobile. Last year, it was below 22%. This year, probably will be trending below 20%. So what's happening is our gross margin is we're not seeing dramatic improvements in gross margin in any individual business. What we are seeing is shift in mix. Mobile is not growing and that's intentional. All of our other businesses in terms of RF, high-performance capacitors, hearing health, ear, IoT, compute within our own microphone business are all growing faster than mobile. So it's very structural in nature, and we intend to continue this process of reducing our exposure to commoditized products.

Okay. So let's pull on that a little bit more. Is pricing a component of your higher margin or is it just mix? And can you provide some color on the margin profile of your various businesses?

Yes. I think of our business in terms of 4 quadrants. First quadrant, which is about 20% of our sales is mobile. Our gross margins there are below our corporate average, which is a little over 40%. And second -- and that's about, again, about 20% of our sales. Second quadrant is our hearing and health business, which is again microphones and speakers, that business is well above the corporate average in terms of gross margin and doing very well GDP-plus growth. Third quadrant is ear IoT, compute for MEMS microphones, the other portion of MEMS microphones, again, well above the corporate average in terms of gross margins and growing at a faster rate, obviously, than mobile. And then, lastly is our PD business, a combination of capacitors and our filters, well above the corporate average in terms of gross margin and growing at a faster rate. So overall, what I would say is pricing is a small component where we've had inflation in the 3 quadrants, hearing health, the ear, IoT, compute and then the PD business, we've been able to pass on inflationary pressures that we've had on to our customers. In our commoditized portion of our business, 20%, it's been a little bit more difficult to do. But again, we're reducing our exposure to that portion of the market.

And maybe just extrapolate a little bit in terms of how you're able to pass on that pricing.

Well I think in a lot of our businesses, we have custom products. And I think it's a very frank discussion with our customers as I kind of heard some other people talk about this, these conversations are never difficult -- I mean, never easy, but on the reverse side is, I think people realize the value of our products in these other segments, where we have highly differentiated products and customers really rely on us as a really important part of the technology that they provide to their customers. So I think I'll give one example. Palladium has been pretty volatile over the last 3, 4 years. If I go back 4 years ago, it was trading at $700 an ounce palladium, as recently as 6 months ago, it was $3,000 an ounce. We've been able to pass on all of that cost increase in palladium that we have in high-performance capacitors by explaining to our customers that here's what's happening to us, and we need to pass this on, and they've been reluctantly willing to accept it.

Great. So let's turn to wafer availability outlook. Is that going to spur higher growth in the second half of the year? And when do you think wafer supply fully catches up with demand?

Yes. I think we've talked a lot about this in last year and into the first quarter of this year, I think -- and even in the second quarter, we've seen wafer supply not matching up with demand. And I've said for the last 6 months that I thought the back half of the year, wafer supply would come into better balance with supply for us. Two things happening, maybe now 3. What I would say, first of all, #1 is I think I've mentioned is, for us, some of our suppliers of wafers, we can get more than we need and others we can't get enough. Now what that means is short term, very hard to switch that mix but longer term, as we introduce new products, we can shift the mix to where we have more supply. That will start happening in the back half of the year as we introduce new products. Second piece is overall demand in the semiconductor market as well as capacity coming online from some of our suppliers should help as well. I would sit there and say is, maybe it's something suddenly that shifted, and I talked about it on the last earnings call is that we are starting to see some weak -- pockets of weakness. And I would say the one I would specifically talk about, which is factored into our guidance was that we already saw the lockdowns in China kind of affecting demand. So we've been able to keep our manufacturing facilities in China open. We haven't had too much supply problems, but some of our customers have had to close down their facilities for short periods of time, but also consumer demand has been weak. And again, that was factored into our guide that we gave for Q2.

Okay. So let's double-click into the business mix a little bit more. So I know smartphones are a market you would deemphasize, but as that market continues to migrate from 4G to 5G, are there perhaps higher content opportunities that you're targeting or is that kind of past?

I wouldn't sit there and say that 4G to 5G, specifically, drives any major content increases for us. I would say higher-end phones generally have higher content. So the more higher-end phones are sold, they do have higher-end content. I would also make this statement, while we're deemphasizing commoditized products, we are still positioned in the mobile market very well that if things change relative to more microphones and/or higher-end microphones get used, we're still very well positioned to take advantage of that. I just think as we look at our business and as we invest, again, our human capital and we invest our CapEx dollars, how we invest, we're going to continue to focus on areas where we have the highest gross margin and the best return on investment.

Okay. So does that mean that you expect smartphones to ever get back to 1/3 of your business or how do you think about the business mix over long term?

I mean, right now, I would say that probably is not like in the cards. I don't see anything in the macros of our business in smartphones that says that smartphones are going to go that direction. And I think it's a couple of reasons: #1 is the smartphone -- the end smartphone market is not really growing, that's #1; #2 is, if you look at the profitability of our customers, we all know the 1 very large supplier makes -- that we show these charts 150% of the profit in the entire market. And so, what we kind of don't see that opportunity today, not to say it won't come someday and we are positioned. But right now, I would sit there and say is, between hearing health, ear, IoT, compute, our RF filter business, high-performance capacitor business, they're better use of our capital at -- whether it be human or our CapEx dollars, a better use of it in order to return money to our shareholders and give them a better return.

Okay. Within those end markets, how would you prioritize your allocation?

Well, that's -- I mean, it's a very interesting question. I don't think we're having any issues where I sit there and say we don't have enough money coming in, in order to fund our organic growth. I think there's a couple of areas I would say that we're pretty excited about. The RF filter business in defense, we're very excited about. This year, it's a high growth business for us. It's got good gross margins. I think our biggest challenge in this business is delivering enough product relative to the demand, especially most of our facilities for this business. In fact, all of them are in North America. Second one, within high-performance capacitors is the EV market. We're pretty excited about our ability to provide high temperature, high-voltage capacitors for high-voltage charging systems, very excited. The hearing health business is quite exciting for us right now. We talked about this on our call -- our earnings call that we've taken some pretty significant share over the last 1.5 year based on execution and technology, and we expect that trend to continue over the next couple of years, plus there's the tailwinds of over-the-counter hearing aids as well as demographics. So I would sit there and say, we have a lot of great opportunities to pursue. And that's what gives me comfort that we don't feel as compelled to chase lower gross margin/commoditized products in other areas, that we have a lot of good opportunities in other areas.

Super. So let's pull on each of those a little bit. So your hearing health business had strong recovery in 2021. What were the growth drivers and what's the midterm outlook for the hearing health market, including OTC hearing is?

Yes I've been involved in the hearing aid market for close to 20 years and what I would just kind of say is it always amazes me the stability of this business. I always go back to '08. It was like a 1 quarter event in terms of growth, in terms of our hearing health business. And I think the reason is, is that if you think about the typical buyer of a hearing aid is being someone who's early 70s, usually, they own their house. They're going to get their social security check every month. They're going to get their pension check every month. And so they weren't impacted by a recession quite in the way that other people were impacted in '08. And we think that's going to happen again. And even through the pandemic, again, we saw 1 quarter in our hearing health business that was very tough when we had lockdowns in Europe and North America, but by the third quarter of 2020, the business started to recover. And so -- and now it's stronger than it was pre-pandemic. And part of it is again share gains, but part of it is also the market's growing. The over-the-counter market is a wildcard here, and I think it's a wildcard that's to the upside. And I'd describe this as only about 5% of people who have mild hearing loss actually have a hearing aid and a traditional hearing aid. And we think the over-the-counter market opportunity is there. It's not in our traditional hearing aid channels of somebody who's 72, who has pretty significant hearing loss, it's maybe for someone who's 60 years old who has mild hearing loss. And the other positive of this is, if I bring someone in to the hearing health idea of wearing a hearing aid at 60, it allows them to say, when they're hearing continues to degrade, we're going to have more cycles of them buying hearing aids over time. So we're pretty excited about the over-the-counter market opportunity. How big and when, a little bit tough to size this out yet. We're really looking forward over the next year or so that there's going to be a lot of brands that are going to come to market with hearing aids, all of which we would be a supplier to.

And you have the same ability to pass on cost irrespective of the end market there?

I think it's a little early to say what the situation is in terms of the over-the-counter market. But I would just say this, the solutions that we provide to the traditional hearing aid market are very, very similar to the over-the-counter market. There's not a lot of difference between the technologies that we're providing. And so, I think it's more about the channel and how people are going to market. I think if you're going to buy a hearing me today, you don't go in and say, I want the Bose hearing aid or I want the Samsung hearing. You get what the audiologist gives you. I think with the over-the-counter market, there's going to be more brand recognition, where someone is going to come to market with a branded hearing aid that you'll know that brand and say, "I want that one," right? And so far, the people who are looking at this market are not pricing the super price aggressively. They're going out and saying, "It's going to be $1,000 for a pair of hearing aids -- over-the-counter hearing aids." There's this belief -- sorry to go on about this, there's just a belief that price is the reason the hearing aid market does not grow. I can show you data after data, that's not the issue. It's not about price. It's about people don't really want to wear the hearing aids. And we're hoping that with true wireless headsets, which has become a big factor in our business, coupled with people realizing the value of hearing better that more people are going to buy hearing aids over time and that stigma will be removed over time.

Super. So let's talk about the MEMS mic business into the PC market a little bit. So you had strong growth in that market in '20 and '21 on work from home and remote learning trends. Now that people are returning to office and school, what do you expect in terms of future growth in computes?

So I mean, short term, we've talked about again this on our earnings call, our compute business has slowed from like, I would say, a frenzied pace in 2020 and 2021. But we're still expecting that our compute business will actually be bigger in '22 than it was in '19. A couple of factors that are positive for us -- I mean, very positive for us. If you go back pre-COVID, how many people actually used the microphones on their laptops? I mean it was very -- I mean, we used to deal with the laptop guys, it was to check the mark I got a microphone, right? Now it's -- everybody is using it, in Zoom/Microsoft's Teams, all these products and using work-from-home, not going away. And so our microphones have become much more integral portion of the laptop/tablet, meaning, #1, they're looking for higher performance microphones, higher ASPs. They're looking for more microphones, more microphones allows you to improve the experience. So I think overall, we're not going to see the growth rates that we saw in '20 and '21 from work-from-home, but the value in this market is definitely there. It's gone from a microphone, it was a check the box to now microphones are a pretty important part of what you're getting when you buy a laptop or tablet.

Great. So then let's talk about high-performance capacitors. This is mostly driven by defense and medtech currently. When do you think other end markets, including 5G and EVs are expected to kick in? And are you supply constrained?

We're not supply constrained. We have a number of facilities that make this in North America and in Asia that make these products. And we've done a pretty good job of staying ahead of the curve in terms of capacity. But this business has been growing at a pretty rapid rate. You kind of mentioned the markets here. Medtech did kind of have a kind of a rough go of it in 2020 when things like pacemakers being put in, we're kind of forestalled with people because of COVID, but that's come back. Our medtech -- sorry, our defense business continues to be strong in this area, some great opportunities there that's growing at a very nice rate. And I think the one that I would highlight that we see is coming over the next 3 to 4 years is EV. We have a number of design wins and again, on the onboard charging systems, specifically for high volts of voltage charging. So where we have, in some cases, cars where we have content of $15 to $20 worth of content per car and so this is a great opportunity for us. This business was a little bit south of $15 million last year. We expect that it's going to have some decent growth between getting closer to $20 million. And I would sit there and say, my biggest thing that I think about from the EV market is we have a lot of design wins, but it's not clear who the winners and losers are going to be in the EV market. And so to the extent that if I have a high content with one of the winners, this could be a $50 million or $60 million business in a few years. If we don't win with the winners, then maybe it's a $30 million business, but it's still going to be a very nice business going forward for us, EV, and we're pretty excited about that market for capacitors.

So the strategy in the EV today is more so try to get on as many programs as possible?

Yes, for sure, for sure. And again, we have a differentiated product. We're not selling generally jelly bean capacitors here. We're selling stuff that's being used in charging systems that has to perform up to 1,000 volts in high-temperature environments. So it's a pretty exciting opportunity for us.

Okay. And maybe just within med tech, can you share a little bit of the products that you're going into, just so people get a sense?

Yes. I think there's 2 primary groups of products that we go into, 1 is implantables, starting with pacemakers. We've got a number of design wins with some new things like insulin pumps. And we've really done a lot of work to kind of try to expand beyond kind of our traditional pacemaker business, which has been very, very good for us into other implantables. That's a great opportunity for us. And then the other area we do sell capacitors into MRI machines. It's not uncommon that we may have on an MRI machine, $5,000 to $10,000 worth of content on an MRI machine. And that business continues to be very profitable for us. I wouldn't say the growth rate has been super high for MRI machines, but I would say it's a very profitable business for us.

But getting back to your earlier point in critical applications --

Critical application.

Critical products.

Correct.

Got it. And then on the defense side, can you share anything on the defense?

Yes. I would sit there and say this is probably -- we'll talk about -- I'm sure our filters in a second, but I would sit there and say that we've really benefited from being one of the few U.S.-based U.S. manufacturing suppliers of high-performance capacitors. And to the extent that we have that ability to manufacture capacitors in the U.S. and were U.S.-based, it gives us opportunities to participate. There aren't that many suppliers of high-performance capacitors in the U.S.

Okay. And then before we leave PD, so on your last couple of earnings calls, you mentioned record bookings in PD. Are lead times coming down or what's happening?

I would sit there and say that we're very lucky in this business, the PD business that most of our products are custom. So there was always this question of our record bookings. Is this being driven by supply chain constraints, people overordering? I don't think the majority of -- there's probably a small component of that, but I don't think the majority of that is a lot of our business in defense and medtech is custom. And so when they order it, it's for them, that we're building for them. It's noncancelable, nonreturnable, and I would say right now, the bookings continue to be very strong. Our biggest challenge has been in the first half of the year with our PD business is delivering as much of the bookings that we're getting. And so, our lead times haven't really come down, and we still are having some struggles in our North American operations to make sure we can deliver all these bookings that we're getting.

And just double click on the struggles in North America operations. What is that? Is that a labor thing? Something --

I would go -- this runs the gamut. In the first quarter, it was Omicron. I mean, we had -- in our North American facilities, we had as much as 20% of our people out direct labor in the first quarter. Second quarter, I would say it's more shifting towards can we hire enough people to further growth. And so -- and I think that's going to be a recurring theme, I think, at least through the rest of this year, which is getting the labor on board trained in order to build the product that's going to be an ongoing challenge over the next, I would say, 6 months.

Okay. Let's talk about RF filtering opportunities and growth outlook also.

Yes. So if I think about this, this was a very, very small business 4, 5 years ago, less than $5 million. This year, it will be probably close to $80 million. And it's driven by a combination of organic growth, coupled with acquisitions that we've done in this space. And so -- and it's all for defense. There are some opportunities maybe down the road in 5G, but it's mainly for defense. And what we've kind of done is we've kind of gone in and built these very specialized RF filters for defense organically that went from about 15 gigahertz up to about 40 gigahertz -- then we went and acquired a company called IMC in San Diego that makes filters from 5 gigahertz up to 20, extended our product portfolio. Our customers trust us in terms of helping them design and then us manufacturing these specialized filters for them. And so, we've got a lot of great like opportunities here going forward. I think this is one of our fastest-growing businesses. And we're very excited about, #1, the ability to deliver the components that we have, but also, we're starting to look more at the idea of delivering an RF module. This is a new opportunity for us that we would have our filters but deliver more content and again, the gross margins are very good in this business. So we're pretty excited about where the RF filter business has the potential to go in defense.

Terrific. And to round out the business conversation, IoT. What are the key drivers you see for this year and next year? Is it wireless speakers, AR/VR, appliances? Are they still part of the equation?

Yes. Yes. Yes. I mean, IoT is such a big market and term, I think one theme I would say about IoT, everything is moving in the direction of being voice-enabled, right? And I think our challenge for us is it's a changing sale for us. It used to be selling to Amazon or Google for a Smart Speaker, which we still do. We're still very successful with them, but that's not where the growth is coming in the future; where our growth coming from the future is from smaller volume applications. Now there are some big ones out there. John has mentioned Bluetooth speakers, but again, portable Bluetooth speakers. You mentioned appliances. We have a lot of design wins in appliances. TVs, I always talk to people, I say, if you think about your TV in your house, why don't you control the TV, the exact way you control your Amazon Echo? Why do you feel compelled to pick up a remote control? And that's because they haven't really provided the infrastructure on the TV in order to make that happen? But it's coming, and it's going to have our microphone content in it. So a lot of good opportunities. I think our challenge is to sell in a different way. We're creating reference designs and helping the smaller customers voice-enabled. I mean -- and I always say it's jokingly, I know there's someone out there who's been saying, "I'm making pens and I want to voice-enable my pen." Well, I mean, how many pens are they going to sell that are voice-enabled? But I need to be able to go to them and give them a reference to sign and say, here's the microphone you use, here's how you put it in, here's how you interface to the cloud. Here's how you do this. And we're starting to get more and more aggressive on this idea that we've got to provide reference designs to these smaller customers because everybody does want a voice enable, and we're in a prime position to take advantage of that with our microphone business.

Excellent. So it sounds like just an increasing base of customers given the [indiscernible]

Yes. Much -- but again, we are, as a company, used to selling to big OEMs, that's what we do. This is a very different sale for us and we've kind of formed a separate team that's really focused on this IoT market.

Great. All right. Let's talk about some financials also in the last, call it, 5 minutes you're here. So you seem to have put a greater focus on free cash flow lately. What are the drivers to achieve your midterm target?

I'm going to let John say a few words.

Excellent.

Sure. In terms of free cash flow, I mean, it's a couple of things. It's increasing EBIT margins, Jeff talked about. Last year, we had operating margins of 20%. We've got a midterm target 22% to 24%, that will contribute an increase in free cash flow. The other is just being a little more disciplined in terms of CapEx, really raising the bar a little bit on our ROIC and our internal evaluation before making expenditure. Historically, our CapEx was running roughly 6% -- 6% to 7% of revenues. I think that will ratchet down a little bit closer to 5% to 6%. So maybe you pick up a percent there. And then last is working capital. We're really focused on really bringing down our inventory, increasing our turns. So those are the 3 levers to increase free cash flow. We've got a target out there of 15% to 17%. We returned 15% in 2021, and we see real opportunities to hit those targets, maybe even earlier than originally anticipated.

Okay. And maybe just on the CapEx front, what is it specifically that you're tweaking that yields that lower percentage?

I would just sit there and say is our MEMS microphone business, in general, is more capital-intensive. And since a portion of that, which is focused on commoditized mics, we are deemphasizing, we're not spending as much CapEx. That's what's really driving it. And so, generally, our PD business, our Precision Device business and our hearing health business are less capital intensive, and that's where our growth is coming from. So again, more structural in nature than us trying to starve the business, right? It's -- we're changing and saying, "I can invest less dollars to get better return in these businesses," and that's what we're going to do.

Okay. And then on the operating margin side, so you've increased more than 500 bps since 2017 to about 20% of revenues right now. What are the drivers that are really yielding that midterm targeted 22% to 24%?

I mean Jeff talked a little bit, it's gross margin expansion, combined with operating leverage. We've done a really good job at controlling our OpEx. And with that top line growth that we've experienced kind of in the mid-to high single digits, we really haven't increased our OpEx at all. If you go back and look at where we were at 2019, we're literally at the same level in terms of OpEx in 2022 in terms of consensus outlook. So it's the gross margin expansion, and that's through mix shift and then on top of that operating leverage.

And I would add, I don't see going forward over the next 2 to 3 years that we're going to have to have significant increases in operating expenses in order to support the growth we expect in the business.

And then on the capital allocation side, you referenced this, but you've approved $150 million increase for share buybacks. And you also stated that you were going to return 50% of free cash flow to shareholders through share repurchases. What factors did you consider to support the decision? And can you provide a range of free cash flow for 2022?

I'll let you handle that last, but I think what we kind of considered is can we fund our organic growth opportunities? Yes, not a problem. #2, can we continue to do acquisitions that we've been doing, what I call bolt-on acquisitions in the PD space? And the answer was yes. And it left us a fair amount of cash flow left over, and we felt it was appropriate discussion with our Board to return that to shareholders. I don't know if you want to talk about the --

Yes, obviously, going to give guidance for the full year on free cash flow. But last year, we generated about just a little over 15% in terms of free cash flow as a percent of revenues. I mentioned on our last earnings call, we expect despite carrying a little higher working capital just due to some of the supply chain challenges we're dealing with, we still should be in a similar level in 2022 in terms of free cash flow generated. We generated in absolute terms, about $133 million last year. We should be in that or slightly above 2020.

I would also add, as we look beyond 2022 into 2023 and beyond and what the midterm model 15% to 17% free cash flow, I personally view I'm more optimistic today about being able to achieve that consistently than I was in November of last year.

Yes. I think some of the inventory that we're carrying now clearly elevated because of the lead times we're having with our supply base. And so, we are carrying higher safety stock at some point, I'm not going to say whether that's Q3 or Q2, it's going to come down.

Yes. And last question from my end. So you exited '21 essentially with no debt. Will this change your capital allocation plans going forward or how is the acquisition pipeline looking probability of closing a transaction in '22 or early '23?

I won't comment about probability of closing the acquisition. But I would say is it's a relatively target-rich environment for us. And so we're going to continue to be very disciplined in what we do. I don't want to do anything that like jeopardizes the great things we got going on. But if we can find something that has great cost synergy with what we already do and/or extends our product portfolio to our existing customers, I think we're in a position to do that, and we will do that if that comes about. As far as leverage, I think you'd say we want to stay investment grade. You essentially have no net debt at this point. And so I think we will put some leverage on the business --

We've communicated a max leverage of 2.5x.

Yes. Yes.

All right. Terrific. Thank you so much for joining us Jeff and John. We appreciate it. Look forward to it.

Thank you.

Thank you.

Thanks, guys.