Knowles Corporation (KN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the 2022 Knowles Corporation Investor Update. My name is Glen, and I will be the moderator for today's call. [Operator Instructions] I will now hand you over to host, Patton Hofer, Head of Investor Relations. Patton, please go ahead.

Good morning. Thank you all for joining us today, and welcome to our 2022 investor update. I'm Patton Hofer, the Vice President of Investor Relations at Knowles. And presenting with me on the call today are Jeffrey Niew, our President and CEO; and John Anderson, our Senior Vice President and CFO. Before we start, I would like to refer you to the forward-looking statements disclaimer on the screen. The presentation 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 laws. Forward-looking statements used during today's presentation will include comments about demand for company products; anticipated trends in company sales; expense and profits and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations. Company urges investors to review the risks and uncertainties in the company's SEC filings, including, but not limited to, our annual report on Form 10-K for the fiscal year ended December 31, 2021, and periodic reports filed from time to time with the SEC. Except as expressly stated in the presentation, all forward-looking statements are made as of the date of this presentation, and Knowles disclaims any duty to update such statements, except as required by law. Please note that all financial references used during today's presentation will be on a non-GAAP continuing operations basis, unless otherwise indicated. Pursuant to Reg G reconciliations of non-GAAP financial measures referenced during today's presentation to the most directly comparable GAAP measure can be found in the appendix included in the slides. A copy of today's slides has also been posted on the Investor Relations section of our website at knowles.com. Finally, we will hold a question-and-answer session at the end of the presentation, so please hold your questions until that time. We will not be answering any questions regarding the fourth quarter. With that, let me turn it over to Jeff to kick off the call. Jeff?

Thanks, Patton, and thank you all for joining us today at our 2022 investor update call. For those of you who don't know me, my name is Jeffrey Niew, and I am the CEO at Knowles. It's been about a year since we hosted our 2021 investor call, and we laid out the strategy for our company and established new midterm financial targets. Obviously, a lot has happened over the last 12 months with the global macroeconomic situation, from rising interest rates and continued COVID-related lockdowns in China, to a significant slowdown in the consumer electronics market, to name just a few. Our strategy to focus our resources and markets and solutions with the highest returns is working, and we have used the last 12 months as an opportunity to accelerate our shift away from commoditized products. Through all these challenges, Knowles expects to end the year with 0 net debt, will continue to be profitable and generate cash. If you are familiar with our story, a lot of what will be presented today will be similar to what you've heard before. But as we announced, we will be sharing details about our new segmentation and the way we report our financials. If you are new to the story, we'd like you to come away from the discussion with a better understanding of the exciting transformation we've executed at the company to focus on attractive end markets, innovative and differentiated solutions and how this combination is expected to drive sales growth, adjusted EBIT margin expansion, EPS growth and increased free cash flow. So let's dive in. Next slide. We have undertaken a plan to fundamentally change Knowles to focus on higher growth markets and reduce our exposure to commoditized products. First, we exited 2 product lines totaling more than $300 million in annualized revenue. Both the speaker/receiver and the crystal oscillator product lines did not have differentiated offerings, were capital-intensive and were low-margin businesses. Secondly, we were quick to realize the untapped potential we had in the ceramic components business in our Precision Devices segment. By running it as a single cohesive business, coupled with some targeted investment and a new leadership team, we recognized this could be a growth platform for the company. First, we took 4 separate businesses and integrated them and unified their channels to market the R&D teams and their customer services organizations, then we stabilized the production processes in our core manufacturing plants. That enabled us to begin to look at accretive acquisitions. Since 2017, we have completed 4 tuck-in acquisitions. These acquisitions expanded our high-performance capacitor and ceramic filtering capabilities and broadened our portfolio of products for defense and medtech customers. Just as important, each one of these acquisitions was accretive to the company's EPS. During this period, we also reallocated R&D spend within our audio businesses to prioritize high-value markets while deemphasizing more commoditized products. More recently, we used the slowdown in the consumer electronics market to restructure our Consumer MEMS Microphone business. This was an acceleration of our plan to reduce our exposure to smartphones and focus on differentiated products in the markets that value our solutions. We reduced overhead in our manufacturing operations and took out operating expenses in the second half of 2022. We expect this to have a large impact on this segment as the consumer market recovers, and we continue to reduce our exposure to commoditized microphones in the smartphone market. Along the way, we dramatically changed our culture and incentive plans to align with our revised strategy. This strategy has a profound impact on our business segments and how we're investing our capital. John will go into more details on this transformation, but our Precision Devices and Medtech & Specialty Audio segments have grown revenue, gross margins and operating margins significantly. While the consumer microphone segment has been challenged by the macroeconomic conditions in 2022, we believe this strategy has allowed us to accelerate the transformation we have been working on for the last 5-plus years. As you saw in our press release, we decided to separate our Audio segment in 2, which provides enhanced transparency into the company's performance. The first new segment will be called Medtech & Specialty Audio, which primarily includes acoustic solutions into the hearing health market. The second is our Consumer MEMS Microphone segment, which is focused on microphones sold into the ear, IoT, compute and smartphone markets. So they'll operate under 3 operating segments: Precision Devices, Medtech & Specialty Audio and Consumer MEMS Microphones. Those portfolios transformed over the years from being a highly concentrated smartphone supplier of audio components towards a manufacturer of highly engineered electronic components to a diverse set of end markets. I want to take some time to talk about the changes we have driven over the past several years and how we expect this to continue to drive earnings growth over the years to come. Our journey started with the realization we were focusing our investment dollars where we were not the leader or in categories with low gross margins. I mentioned that we'd made significant changes to our portfolio over the years and while has taken time to complete, these changes have resulted in an improved product portfolio across a diverse set of growing end markets that's delivering revenue growth, gross margin expansion, improved earnings and driving better cash flow. We achieved this by focusing on market segments that value our differentiated solutions and those with the most favorable growth prospects like defense, medtech, ear, IoT and electric vehicles. We have shifted our R&D and CapEx investments to support these high-value growth areas away from lower-value commoditized markets. We also expanded through M&A, delivering accretive returns from growth markets and, at the same time, strengthened our balance sheet through debt reduction. With this zero net debt expected at the end of the year, we have even more flexibility to continue to focus on organic growth initiatives, larger accretive acquisitions as well as continue to return capital to shareholders through our commitment to return at least 50% of our free cash flow through share buybacks. Before I dive into the details on our 3 segments and the expectations going forward, I want to briefly cover how we differentiate our solutions across our markets. Knowles has a long-held reputation for delivering high-performance products across the end markets we serve. We have decades of unique and value-added manufacturing expertise, and we are capable of creating innovative solutions to complex technical challenges that allow our customers to deliver new product features and applications. Knowles designs, manufactures and delivers these products. This vertically integrated operating model allows us to quickly adapt to market trends and the changing demands of our customers. Our unique design capabilities and manufacturing processes also enable our customers to differentiate their products, and that's why some of the world's most respected companies rely on our technologies. Now onto Precision Devices. In the Precision Device segment, our high-performance capacitor and RF filtering solutions enable some of the most demanding applications in the defense, medtech and EV markets, and our innovation and creativity in the manufacturing processes allows us to continue to be a leader across the markets we serve. Our capacitor portfolio includes products with highly specialized requirements, including high voltage, temperature and reliability. The specific markets we serve include defense, medtech and EV. In the defense market, we are a leader in capacitors serving radar, space and airborne applications, and we are seeing rapid growth in the defense communications arena. In medtech, we enjoy a very strong position for capacitors in both MRIs and implantables and anticipate continued strong growth in demand from this market. In the MRI space, we provide a full range of nonmagnetic capacitor solutions. Our customers in the implantable market trust our experience, high reliability and product range and testing capabilities for these mission-critical applications. In the EV market, we use proprietary ceramic formulations to develop and manufacture high-voltage and heat-tolerant capacitors that are used in a host onboard applications from battery management, onboard charging to e-compressors. We are seeing a growing list of design wins across multiple new platforms with our products and expect this market to grow at a rapid rate. We also deliver high-performance ceramic filtering solutions across a broad range of applications and frequencies. In the defense market, our devices are used for narrowing the spectrum for improved target identification as well as filtering signals to detect and block enemy radar. We expect demand for our filters in the radar and defense and communication markets to continue to grow at high single-digit CAGR because of the large investment the U.S. and its allies are making in next-generation radar and general platforms. We continue to believe our strong competitive offering, coupled with the tailwinds in our end markets, will allow us to grow organically the segment 5% to 8% annually over the next 3 to 4 years. Lastly, as discussed earlier, we have a track record for completing accretive acquisitions within our PD segment. We've done 4 acquisitions since 2017, all successful in either adding to our share in the markets we compete in or expanding our product portfolio. This is a target-rich space. And we believe this, coupled with our strong balance sheet and future cash flow, provides an opportunity to grow revenue and earnings at an accelerated rate over the next few years. The hearing health business has proven over a long period of time to be a steady growth market where we offer differentiated acoustic solutions. For more than 50 years, we have been helping leading hearing aid companies deliver life-altering devices that enable people who are hearing impaired to then have an improved quality of life, whether it be size, broad frequency response, low power or working directly with our customers to develop custom acoustic modules, our microphones and balanced armature speaker solutions deliver industry-leading performance and reliability. In addition to the traditional hearing aid market, there are a number of new market opportunities. Chief among these is the over-the-counter market. It is estimated that about 28 million Americans suffer from mild hearing loss, yet only 5% use a hearing aid. This is the potential user who could benefit from the release recently implemented FDA rules for over-the-counter hearing aids. We are cautiously optimistic about growth in the market in light of the recent OTC announcements from Walmart and Best Buy in the channel side to Sony and HP on the product side. Lastly, in the consumer ear market, we are seeing an industry push to define and adopt a high-definition audio standard. This would enhance consumers' music listening experience by including higher frequencies not provided today with traditional true wireless headsets. Our balanced armature speakers are a logical option to enable this. With all this, we see Medtech & Specialty Audio segment growing at a compounded annual growth rate of 2% to 5%. Our MEMS mics are ubiquitous for voice capture across many consumer devices and have become even more important as voice becomes a primary user interface. While 2022 has been a challenging year for most consumer electronics markets, we are well positioned to continue to diversify away from the commodity portion of this market, mainly smartphones, when the market recovers. Historically, we designed mics for smartphones and then drove solutions into other end markets. Now we are designing microphones for specific end markets and optimizing them for the characteristics that are most important to our customers in their specific application. Ear is one of the most exciting opportunities for Knowles over the next several years, where we are able to leverage a distinct set of capabilities to tackle customer challenges. Unit growth for solutions like PWS earbuds has been strong, and we expect that to continue in the future. The IoT market for Knowles was primarily driven by the adoption of smart speakers. But over the last few years, we have seen the IoT category expand to include devices like security cameras, doorbells, TVs, white goods and AR/VR headsets, among other products. This has always been a key area of focus for our microphone business, leveraging our capabilities to capture sound from a distance and solve challenges related to background noise. The move from work to home and remote schooling reminded people around the world how important voice capture actually was. As employees and students around the globe upgrade their devices, they begin to expect more from their online communications. As the market leader for microphones in the compute segment, we benefited from these trends. While the compute market is under pressure today due to weak consumer demand, we expect to continue to have strong share and benefit when the market recovers. Finally, smartphones still represent a sizable market for us, but we believe this will be a smaller portion of our business in the years to come as we continue to deemphasize commodity products. We continue to believe our strategy to focus on differentiated products in the end markets will allow us to organically grow this segment 0% to 4% annually over the next 3 to 4 years. One of the most important goals our team has achieved is the successful transition of our business from a predominantly smartphone-focused supplier to a diversified electronic components supplier. We've increased our exposure to growing end markets, where we have strong competitive positions and where our differentiated solutions are valued. At the same time, we've reduced our reliance on smartphones from 35% of revenues in 2018 to roughly 16% this year. This diversification has resulted in a number of benefits, including reducing single customer exposure and improving gross margins. All of our markets have good growth opportunities and strong gross margins with the exception of smartphones, which we'd expect to continue to decline as a percentage of our total company revenue as we continue to implement our strategy to focus on higher-value products and markets. Before I turn it over to John to cover the financials, I'd like to summarize. Knowles will begin reporting at the end of 2022 with our new segments to provide additional transparency and to be more reflective of the way we manage the business. It also demonstrates the profitability and resilience of the Precision Device and Medtech & Specialty Audio segments. In the future, we expect revenue growth to be primarily fueled organically through the markets we serve specifically, and we anticipate strong tailwinds in defense, medtech, ear, IoT and EV markets, layered on top of more modest growth in industrial and a return to growth in computing. Next, the intensity [ of ] gross margins will be driven by continued mixed improvement to higher-value products and markets, the benefits from our restructuring we announced in August and by new products we expect to introduce into the markets we serve. For operating expenses, we will continue the discipline we have already demonstrated. We will continue to invest in R&D and products in markets where we're the leader and in categories with high gross margins. Finally, for capital allocation. We have a history of accretive M&A in Precision Devices. And with our future cash flow generation and strong balance sheet, we expect to have significant capacity to continue to supplement our organic growth through strategic M&A while continuing to buy back shares. While we expect to be a smaller, higher-margin business, we are on a path to getting to $2.50 of EPS and expected this to be shifted out by 1 year. I will now turn it over to John to discuss how this strategy will drive our financial results over the years to come. John?

Good morning. For those of you that don't know me or I haven't yet met, my name is John Anderson. I'm the Senior Vice President and Chief Financial Officer at Knowles. I'm proud to be part of the management team that has been instrumental in reshaping the company over the last several years. It's been a year since we introduced our current midterm financial targets, and I'll spend a few minutes today to provide an update on the progress we've made toward delivering on these targets. I'll also be presenting several key historical financial metrics for each reporting unit under the new segment reporting structure that we announced earlier this month. Lastly, I'll present the drivers for future gross margin expansion and cash generation, along with our capital allocation priorities. Moving to Slide 16. As Jeff mentioned earlier, our Precision Devices and Medtech & Specialty Audio segments have demonstrated consistent revenue growth, coupled with expanded gross and operating margins, while the Consumer MEMS Microphone segment has been negatively impacted by challenging macroeconomic conditions in 2022. Since 2018, total company revenues have declined by $49 million, with the decline driven entirely by our Consumer MEMS Microphone segment, partially offset by growth in both the Precision Devices and Medtech & Specialty Audio segments. Our strategy to invest both our dollars and human capital in products and markets that yield the highest margin is driving improved financial performance. Specifically, total company adjusted EBIT and adjusted EBITDA margins are expected to increase by 400 and 390 basis points, respectively, over 2018 levels. While we have delivered profitable revenue growth, including gross margin expansion of more than 400 basis points in both the Precision Devices and Medtech & Specialty Audio segments since 2018, the weak global demand for consumer-facing markets has negatively impacted 2022 gross margins in the Consumer MEMS Microphone segment. I'm confident that the recent restructuring actions we announced are on track to deliver more than $25 million in annualized savings and that we are well positioned to see improved margins in both the Consumer MEMS Microphone segment and on a total company basis in 2023. Now let's dive into the details by segment. Our Precision Devices segment is expected to deliver annual revenue growth of just over 14% since 2018, driven primarily by defense, medtech and EV markets. This growth rate includes organic growth of 9% and additional 5% coming from acquisitions. In addition to double-digit revenue growth, Precision Device gross margins and adjusted EBIT margins are expected to expand by over 400 basis points from 2018 to 2022. The margin increase has been driven by improved pricing, factory productivity improvements and 4 acquisitions, each of which are delivering above-average gross margins. Over the past 5 years, we've also expanded adjusted EBITDA margins by 340 basis points, resulting in a near doubling of adjusted EBITDA from $40 million in 2018 to an estimated $76 million in 2022. Given our proven track record of delivering profitable growth, despite a global pandemic and a challenging macroeconomic environment, I'm confident about the resilience of the Precision Device segment and its ability to continue to deliver annual organic growth in the mid to high single-digit range with above-average gross margins. Next slide. As I mentioned, the Medtech & Specialty Audio segment was previously reported under the Audio segment. We elected to break this out as a separate segment to provide enhanced transparency into the company's financial performance. In addition, the new segment structure better aligns with Knowles' strategy and how management reviews its financial results to drive business decision making. Revenues in this segment are expected to deliver 2% annual growth since 2018, which correlates closely to the growth rate of the hearing aid market. Similar to the Precision Device segment, the Medtech & Specialty Audio segment has delivered profitable growth, despite the global pandemic and a challenging macroeconomic environment. Gross margins are expected to increase by 660 basis points from 2018 levels, and we expect to deliver gross margins just under 50% in 2022. The gross margin expansion has been driven by new product introductions, improved productivity and a strategic shift away from low-margin business. Over the past 5 years, we've also expanded adjusted EBIT and adjusted EBITDA margins by 660 and 740 basis points, respectively, resulting in a 33% increase in adjusted EBITDA from $68 million in 2018 to an estimated $90 million in 2022. Looking ahead, we expect annual growth in this business to accelerate slightly from historical levels to 2% to 5%, driven by an aging global population, over-the-counter hearing aid market penetration in the U.S. and high-definition audio for higher performance through wireless devices. Moving to Slide 19. Over the past 12 months, we've talked a fair amount about our strategy to focus on high-value products and markets and reduce our exposure to commodity microphones, particularly in smartphones. The Consumer MEMS Microphone segment revenues declined slightly between 2018 and 2021 as our strategy to move away from the smartphone market was partially offset by growth in non-smartphone applications like ear, IoT and computing. Our strategy worked, and our smartphone exposure was reduced by nearly 40% over that time period. In 2022, the significant revenue decline was primarily driven by the weak global demand for consumer electronics. We used this decline as an opportunity to accelerate our strategy to diversify away from commodity microphones and announced restructuring actions to reduce capacity and shift our R&D efforts to products and markets with higher margins. We expect the smartphone business to be approximately 16% of total company revenues in 2022. Now I want to provide a brief recap of our microphone restructuring. When announced, the estimated restructuring benefits were $25 million to $30 million in annualized savings with roughly half the savings coming from factory overhead and the remainder from a reduction of operating expenses. I'm pleased to say we're on track toward those estimates, and all of the cost-reduction actions will be in place by the end of this year. We expect that lower-than-normal microphone capacity utilization will continue into the first half of 2023. As inventory is drawn down and we return to more normal production levels, we expect gross margins to expand through higher capacity utilization. In addition, as demand in global consumer-facing markets improve, we'll have the opportunity to be more selective in the business we pursue. And we are well positioned to benefit from favorable mix shift. Next slide. As I've noted, 2 of our 3 segments have very attractive gross margins, and we expect to improve gross margins in the Consumer MEMS Mic segment. Now I'd like to walk through the 3 primary drivers to achieving gross margin of 43% or more. First, the continued shift of our portfolio to high-margin products and end markets is expected to yield 150 basis points or more of improvement in total company gross margins. This will largely be driven by the expected revenue growth in our Precision Device and Medtech & Specialty Audio segments. Second, the benefits from the restructuring actions we announced in August are in place and expected to yield 100 basis point improvement in total company gross margins. Third, as global consumer-facing markets recover, we expect the Consumer MEMS Microphone business will benefit from both higher capacity utilization and favorable mix shift, which is expected to improve total company margins by 100 basis points and return margins in our Consumer MEMS Microphone business back to historical levels. Next slide. We've demonstrated our ability to improve free cash flow generation as evidenced by an increase in free cash flow margins from 2.2% of revenue in 2018 to 15.4% of revenues in 2021. From a free cash flow standpoint, 2022 has proved to be a challenging year as it has been negatively impacted by the significant reduction of demand in consumer MEMS microphones and the related rise in inventory levels by more than $40 million over the first 9 months of 2022. As we move into 2023, we expect free cash flow as a percentage of revenue to return to 15% or more with the improvements over the current year, driven primarily by more normal inventory levels, the cost savings from our restructuring plan and profitable growth in our high-margin segments. Next slide. Since 2018, we paid off $155 million of debt, completed 5 accretive acquisitions for more than $165 million and returned $105 million to shareholders through our stock repurchase program. As we look ahead, our priorities have not changed. We'll continue funding the internal initiatives with the highest return on investment, target returning 50% or more of our free cash flow to shareholders through stock repurchases and pursue value-creating acquisitions. Based on our expectations that we'll exit 2022 with near-zero net debt, coupled with our projections for increased free cash flow generation, we expect to be well positioned to increase the amount of capital that we deploy for acquisitions and share repurchases. Next slide. I'd like to conclude my presentation with an update on the timing of reaching our midterm financial targets of adjusted EBIT margin of 22% to 24% and free cash flow as a percent of revenues of 15% to 17%. When we introduced these targets last year, we planned to achieve these targets within 3 to 4 years. I'm pleased to say that based on the overall financial performance in our Precision Devices and Medtech & Specialty Audio segments, along with our improvement plan for Consumer MEMS Microphones, we're expecting to achieve our midterm targets in the next 1 to 2 years, which is a year earlier than originally planned. As we exit '22 and look ahead, we expect our transformation into a diversified electronics manufacturer will continue to enable further operating margin expansion and generate significant free cash flow. Our internal growth plan, supplemented with a strong balance sheet and robust M&A pipeline, positions us well to drive strong earnings and cash flow for our shareholders over the next several years. With that, I will turn the call back to Jeff, and then we'll move to Q&A. Jeff?

Thanks, John. Before we move to Q&A, I'd like to make a few final comments. I'm very pleased with what we've accomplished over the past few years, and we hope that you are as excited as we are about the future. While 2022 has been a challenging year for our Consumer MEMS Microphone segment, we have demonstrated the resilience and potential for continued growth in revenue and earnings in the Precision Devices and Medtech & Specialty Audio segments. Going forward, we believe the resegmentation allow you to see -- better see the value of our different businesses as we continue to transition to higher gross margin products and markets. We will continue to be disciplined with our R&D investments and CapEx spending, focusing on maximizing adjusted EBIT margins and cash flow. Our strong balance sheet will allow us to continue to pursue accretive M&A in our Precision Device segment while continuing to buy back shares. We'll now open it up for questions.

[Operator Instructions] Our first question comes from Bob Labick from CJS Securities.

And thanks for a very nice presentation and some new information and details.

Welcome, Bob.

Thank you, Bob.

So I just wanted to start, given the change in the emphasis, the shift to higher-margin products, how much of the change in the new Consumer MEMS Mic segment -- I think it was down maybe $130 million from last year to this year. How much of that is kind of walking away from low-margin business or just the macro environment, the inventory correction going on there with demand? And where does that -- this year's [ 306 ] settle out once we get back to a normal inventory environment?

Yes. So that's a great question. So let me parse this out a little bit for you, Bob, and everyone's listening. So it was -- if you go back to 2018, our mobile business was just short of about $300 million in sales for the segment. And even of the $470 million or so was -- is $300 million. If you go to 2021, last year, it was down to about $180 million, $185 million. That was all us choosing to move away from mobile business. So we were kind of walking away from that business. Now if you go from '21 to 2022, obviously, there's a different dynamic here. We've got demand across all of our consumer electronics markets are down. But about $60 million, it was down additionally, mobile, from about $180 million, $185 million down to $120 million. I would say that isn't as much us walking away from business as the market being down. Now as we look forward, Bob, what I would sit there and say is this, we had a choice. Do we want to take that mobile business back when it recovers? Or do we want to be that size or smaller in the mobile business, $100 million, $125 million? And my answer to that is we chose to restructure. And so that we're not going to go back to $180 million in the mobile business. And so if you sum this all up, I would sit there and say, over time, the mobile business will continue to decline. The rate at which it will decline is dependent on when the inventory correction and the end markets take -- is complete and when the recovery of the market comes. And so I think we're sitting there saying this business from where it's this year is going to grow 0% to 4%. Now the shape of that, how it grows, probably based on the market recovery, but we're not going to go back and continue to service lower-margin mobile business.

Got it. Great. That's really helpful. And just talking about that, can you talk about kind of big picture, some of the synergies between maybe this lower-margin consumer business, MEMS, and any other segments? Or might there be more portfolio optimization over time? Or how are you thinking about this business as it fits into the -- into your entire portfolio?

Well, Bob, if you will look at the other portions of the Consumer MEMS business, it's the ear, IoT, compute. Those are good gross margin businesses. Now obviously, it doesn't show through this year with the capacity underutilization for the full year. But as we get back to full capacity utilization, you'll see this kind of through. And we would expect to get back to historical levels, which you can see in the appendix every year what the gross margin was in this business, we expect to get back to historical levels, right, albeit a smaller business. In the meantime, we've taken out additional operating expenses. We have lower operating expenses, which you'll be able to see and all the details as well. As far as the synergy, I mean, the big synergy still is this, that we do sell a fair amount of MEMS microphones in the hearing health business, and they are benefiting from a lot of the R&D work that goes into the consumer business, but we are modifying significantly our MEMS microphones that go into the hearing health market compared to the consumer market.

Got it. Okay. That makes sense. I can ask one more or jump back in queue? What's best? Okay.

Go ahead.

Okay, super. And given the kind of inventory cycle is so pronounced out there. I guess, 2 kind of questions around this. How are you thinking about the demand cycle over the next 12 to 24 months? And I guess is the cyclicality really just in the kind of consumer business? Because your other businesses seem to not be very cyclical at all. So maybe give us a sense on view on cyclicality. And then the dynamic of -- we may be going into a recession, but if inventory gets cleared out, we may have some kind of recovery in that sell-in business as well. So how do you put all that together and think about the next 24 months?

Yes. Let me just give you kind of some commentary by the different segments. In the Consumer MEMS Microphone business, I would sit there and say is, I'm not going to be the guy who's going to predict a recovery. I think we've been pretty clear now saying that we're really not seeing the recovery through Q1, probably into Q2. But at some point, it's going to recover. And again, growth may be limited in our business as we kind of still walk away from additional mobile business. So just to be clear. Now you're right. If inventory gets cleared out, a flat market should result in some growth in this market, right? So I think that's kind of what we see is that at some point, people are going to need new PCs and laptops. At some point, people are going to buy more consumer electronics, and we're going to benefit from that when it happens. Now in the other 2 segments, in the last call, I was pretty clear. In our hearing health business, we have seen a little bit of slowing down in this business compared to what we had expectations going into the year. But it's nothing near the magnitude in, that we're talking about, the general consumer marketplace. As I said, when I talk to my customers in the hearing health side, they might have been expecting 5%, 6% -- 4% to 6% unit growth. Now they're expecting like 0% to 2% unit growth, right? So it has slowed down a little bit, but again, nothing of the magnitude that we see in the consumer microphone plays. And then lastly, the Precision Device business, I mean there's one portion of this business that I would say that we monitor pretty closely, and that's what I'd call the industrial/distribution business, which is, I would say, everything else. It's not the medtech; it's not the defense; it's not the EV. And so far, it's been holding up. I wouldn't say it's growing at the rate it's been growing, but so far, it's been holding up. But medtech, defense, EV, we're still seeing strong growth. And based on a lot of these areas like medtech and especially medtech and defense where we have long-term contracts and bookings, we have strong bookings for next year already, I mean, at this point of the year. And so -- and a lot of this is, again, custom stuff that we're not just stocking shelves. And so we think the Precision Device segment is still going to be very resilient going into next year and beyond.

We have the next question comes from Suji Desilva from ROTH Capital.

Jeff, John, thanks for the comprehensive update here.

Thanks, Suji.

Thanks, Suji.

Yes. So just give me a sense of how to think about the microphone business kind of product development going forward versus the past. I'm curious if there's kind of things that we don't quite see about what it meant to be trying to support volume smartphone programs versus now how it's going to be targeting other markets? Just the product development effort is different in any meaningful ways.

Yes, it's very, very different. If I were to go back 2016, 2017, when -- again, I kind of said 2018, it was close to $300 million of the $470 million, we would develop microphones for the mobile market. And then once they were complete, we would take those and market them to the other markets. What's changed now is the product development has been stratified to say, look, we're not making as much money in the mobile market as we can make in these other markets. And so what we've done is we've allocated more resources to developing microphones that are specifically for ear, IoT and compute. Now -- and then I say that is the requirements are very different, right? And I'll give you an example is ear. Power is very important, much more important than it is in the mobile market. Size is much more important in the ear market. If you look at IoT, picking up a voice signal from 25 feet away is much more important than it is in a mobile market. And so we're optimizing these microphones. The R&D has to think about those things. And so we're not developing -- we're using all our R&D dollars towards mobile and then saying to everybody else, this is what you get.

That's very helpful insight, Jeff. Appreciate it. And then just want to understand with the changes in the smartphone MEMS Mic business, will there be any change in your lead customer relationship and how that supply relationship will change? And is there an opportunity for you guys for high-def audio and the speakers that's meaningful near term?

Yes. So let me take the first one first. I'm not going to talk about anything about any specific customer relationships. I think generally speaking, what we're viewing is that we're not going to exit the mobile market, but we are being more selective in where we take business. I think that's what we're saying, right? And so -- and that goes across the board with all of our customers, right? We have to think about that. As far as high-definition audio, we've done a fair number of press announcements over the last 6 months with reference designs that talks about high-definition audio. We're getting some of our customers as well as some industry experts looking at high-definition audio. What I would sit there and say is, today, the majority of the true wireless headsets that are in the market kind of cut off at about 10,000, 11,000 in terms of frequency. We're seeing this kind of push to be -- there's a lot of sound that's out there in 12, 14, 16 kilohertz and the balanced armature speakers are being looked at very seriously to try to enable these very high-performance headsets where you really can hear the difference. And I encourage anyone on the call, we can get back to you or through Patton with some of the headsets that have already implemented this. And I could tell you, it is a very noticeable difference in when you're listening to audio to have a high definition or higher frequency response from your speakers, and we help to benefit that. Now I'm going to say this, we're not going to go down a raffle of chasing low gross margin business. We want to be a premium supplier in the marketplace. And I think we've talked more about that, that in our balanced armatures for the consumer space, the gross margins albeit maybe it hasn't grown as fast as we hoped, the gross margins and the ASPs are significantly higher than we had expected, say, 2 years ago.

Okay. Sounds like an exciting area. Last question about the auto EV market. You talked very much about the PD products that are there. I'm curious if the automotive microphone market is an attractive market or not. And if so, why?

It's an attractive market. I would say it falls into what we consider our IoT kind of space, but it's not a huge market. And so let me kind of give you kind of my thoughts here. Where we really excel is things where the devices need to be small and they need to be very low power. Power is not -- is important in a car. When you think about the power of the microphone and size is not as important. Now we have a fair amount of business in this market. But I would say it's one of many applications in what we consider the IoT space where we have opportunities to sell microphones.

We have our next question comes from Christopher Rolland from Susquehanna.

This is Matt Myers on for Chris. I wanted to ask on capacity utilization in MEMS mics. Just curious where the levels are now versus, say, a year ago? And I know you said that you expect it to be depressed through the first half of next year, but how do you expect the return to be? Is it back to where it was? Or do you expect more of a linear return?

Yes. I mean I think just to be clear, we're dealing with 2 separate issues here, right, in the here and now. And we talked about this on the Q3 call, which is, first of all, the demand is down in the Consumer MEMS Microphone business. So we probably wouldn't be operating at an optimized level of capacity utilization right now, even if we weren't dealing with the second issue, which is inventory, right? We have a fair amount of inventory. You can see it on our balance sheet, and we got to start working towards getting that down. And so this quarter, we're -- I would say we're running in the roughly 50% range. And as we said again on the Q3 call, we expect that to continue at least through Q1, maybe into Q2. John, anything more color on that?

No, I think you nailed it. I mentioned in the last call that we were just about 50% to 60% capacity utilization. And as we work down inventory, our own inventory, that should come up slightly, but we expect to be well below our targeted capacity utilization through at least Q1 and maybe Q2 of 2022.

Yes. And keep in mind, this is 50% of a -- if you think about it, this is 50% of a reduced capacity level because of the restructuring we did in Q3. So if we were to think going back to the capacity utilization would have been on our older capacity pre-restructuring, it would have been even lower.

Got it. That's helpful context. I wanted to ask also on ASPs for traditional versus OTC hearing aids. I was just curious about the content differences and your thoughts there.

Yes, the content differences are not different at all. I mean what we're seeing is typically balanced armature speaker 1 or 2 and 2 microphones, like we would in the traditional hearing health market. Obviously, the ASPs of the end market are lower, but they're not dramatic. I think when we talk about this market, you can go to Costco. And I believe you can buy a pair of hearing aids for $1,300 and see an audiologist. A lot of what you see, Bose has introduced hearing aids, now Sony has announced hearing aids. They're in the $800, probably at the low end, up to about $1,000 to buy an over-the-counter hearing aid. That's without obviously seeing an audiologist. So the ASPs are a little bit lower. But if you think about where some of the consumer companies are coming from, they're coming from ASPs for a headset at the high end, maybe $250 at the high end, probably $100 at the low end. These are significant increases in ASPs for them. So our content is very similar.

[Operator Instructions] We have our next comes from Anthony Stoss from Craig-Hallum.

Congrats on getting to your midterm goals it looks like a year early. Jeff, I wanted to focus on the $2.50 non-GAAP EPS bogey that you threw out there. I'm curious how much do you need to get to in [ REMS ] and margins to get there? How much is coming from or expected to come from M&A? And what kind of time frame? Then I have a couple of follow-ups after that.

So I'll let John kind of cover that, then I'll kind of put some color right at the end.

Yes, Tony. So if you take the assumptions that we laid out today, so top line growth in the mid-single digits, gross margins getting to 43% or more, you organically will have, call it, $2.20 to $2.30 in years, kind of 3 to 4. And then so that leaves $0.25 to -- $0.20 to $0.30 coming from a combination of share repurchases and acquisitions.

And I'll just add the color, that's about what's come over the last 4 years from acquisitions, about $0.20, so…

And with a debt-free balance sheet and strong future cash flow projections, we should be able to do more than we've done historically in those 2 areas.

Yes, makes sense. And then, Jeff, maybe for you. Curious how much -- or what are your future plans in the automated BA line? And what do you expect from that on the margin front?

Yes. So that's a good question, Tony. So I think, obviously, we've been hampered somewhat by the weak demand for consumer electronics. And specifically, a lot of the designs we've been working on have been in China, and it's obviously a very fluid situation in China right now. And it's been this way now for extended period of time. Now that being said, I think our expectation is that we will eventually fill this capacity. But I think we are really focusing on with premium audio, we want to focus. And so what we have in business today going into next year is, I would say, significantly higher in ASP than we had at one time expected. I think we at one time had talked about $1. And I'm not going to go into specifically the ASPs, but the ASPs are like a magnitude higher right now in terms of what we're doing. So the gross margins are better. Secondly, I think over time, the other thing that's happened with the balanced armature line is we're getting more interest from the traditional hearing health market. And the reason that they're interested in this is they've seen some of the challenges we face and other suppliers face in terms of inflation. This takes out an inflationary piece of the [indiscernible]. We have the materials, but there's not as much labor content with this. And then I think the other thing that's kind of changed here is we're starting to see this being utilized potentially for the over-the-counter market as well. So I'm confident we're going to fill this line. I'm not going to lay out the exact date it's going to be built, but I can also say this. We will fill it at a significantly higher ASP and a significantly higher gross margin.

Got it. Makes sense. Saved the toughest question for last. Just a lot of commentary on this call and on prior calls, frankly, talking about walking away from the mobile business and deemphasizing and not spending money on it. Why not just sell the division or license the rights to somebody else? Let them monetize it. Let them spend the money and try to grow revenues.

Well, I'm not going to comment on that. I mean obviously -- but I mean, we see great tailwinds in our other businesses, PD, Medtech & Specialty Audio as well as ear, IoT and computing, our good gross margin businesses within the MEMS Microphone business. And I'm not going to call it the recovery of the market. But I think from our perspective, we're focused today on continuing to meet our midterm financial goals.

[Operator Instructions] We have no further questions on the line. I will now hand back to Jeffrey Niew.

Thank you again for joining us today. And we hope if there's any follow-up questions or more information, obviously, we're going to be providing a lot more detail when we announce our Q4 results, which will include the 10-K and all the details on the new segmentation. But if there's any questions in the meantime, Patton is available in order to answer any questions, and thanks for the time.

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.