Good afternoon, and welcome to the Knowles Corporation first quarter 2022 financial results conference call. Today's call is being recorded, and all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session, and if you would like to ask a question during this time, please press star one on your telephone keypad. If you would like to withdraw your question, please press star one again. With that said, here are the opening remarks with Sloane Bolun, Investor Relations.
Thank you, Savannah. Welcome to our Q1 earnings call. I'm Sloane Bolun, and presenting with me on the call today are Jeffrey Niew, our President and CEO, and John Anderson, our Senior Vice President and CFO. Please be advised that today's conference call is being recorded. By now, you should have received a copy of our earnings release and webcast slides. If you do not or have not received both documents, they are available on the IR section of our website at knowles.com. 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 laws.
Such forward-looking statements include comments about demand for company products, anticipated trends in company sales, expenses and profits, and future financial outlook, 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 31st, 2021, periodic reports filed from time to time thereafter with the SEC, and the risks and uncertainties identified in today's earnings release. 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, we have provided both GAAP and non-GAAP financial measures on this quarter.
All references on this call will be on a non-GAAP continuing operations basis, unless otherwise indicated. Please see our earnings release and webcast slides available on our website at knowles.com and in our current report on Form 8-K filed with the SEC for a reconciliation of the most directly comparable GAAP measures. With that, let me please turn the call over to Jeff, who will provide some comments on our results. Jeff.
Thanks, Sloane, and thanks to everyone for joining us today. We are very pleased with Knowles' performance to begin 2022. As you saw in today's release, we reported another quarter with gross margins and EPS above the high end of our guided range. Best of all, we achieved these results despite stronger-than-expected headwinds from the reemergence of COVID in mainland China, dampening demand and causing additional friction on an already stretched supply chain. I will touch on our near-term expectations for these headwinds in a moment, but before I do, I want to reiterate our conviction to the midterm financial targets we detailed at our Investor Day last November. Our year-to-date results, particularly in our Precision Devices segment, have only increased our confidence in those significant opportunity to drive shareholder value through continued growth in higher margin end markets with highly attractive free cash flow dynamics.
With that, let me give you a summary of our strong first quarter results. Revenue of $201 million was in line with our guidance, driven by a mix of very strong demand in Precision Devices and continued market growth and share expansion in Hearing Health. Precision Devices segment revenues totaled $56 million in the first quarter, which was up 47% compared to a year ago, with the vast majority of that growth being organic. Additionally, the Precision Devices segment delivered another record quarter for bookings. The demand for this segment was driven broadly across most of our end markets, and it's rewarding to see our strategy so well aligned with long-tailed secular drivers. Turning to Audio, our Hearing Health business continued to show good growth as the end market for these products remains robust.
We continue to have strong execution on new products and managing ongoing supply chain issues, which has allowed us to gain share. While the MEMS microphone business did not grow year over year for the quarter, it is performing in line with expectations as we focus on higher margin products and markets. Looking ahead, this year's new product pipeline from our customers is more weighted to the back half of the year, which is typical seasonality for this business. Next, I would like to give a little bit more detail on the macroeconomic headwinds impacting our business before I speak to our continued success on profitability. As you are hearing elsewhere in the industry, supply chain challenges remain very real and were for Knowles in the first quarter as well. While it's very difficult to predict what will happen next, it is impacting our business at this point.
Beyond supply chain challenges, we have increasingly seen the latest COVID outbreaks in China and associated government lockdowns impacting consumer demand for smartphones and other consumer electronics. This is causing demand headwinds in our MEMS microphone business. While both challenges are fluid situations, we believe the impact on our business will persist the first half of the year. We'll provide more detail when discussing the Q2 guidance, but we do not expect to affect our ability to achieve our midterm financial targets. The issues in China highlight the benefit of our revenue diversification and reinforce our commitment to continue to shift to higher value products and markets, which are inherently less economically sensitive to consumer demand. With that, let me turn to our profitability. Knowles grew gross profit to $83 million, up about 7% compared to the year ago period on essentially flat revenue.
The major driver of the strength was Precision Devices segment, where margins were up 920 basis points year-over-year on favorable mix, pricing power, and the IMC acquisition. It is worth noting our 2Q margins will face a more challenging year-over-year compare given the current lower factory capacity utilization in our MEMS microphone business. That said, I am very pleased with the progress we continue to make on margins, especially given the macroeconomic headwinds in the MEMS microphone business. Our strategy, strong execution, and expense management has allowed us to achieve adjusted EBIT margins of close to 20% for Q1, an increase of 250 basis points over last year. Similarly, we grew EPS to $0.35 per share, which is also above our guided range and represents over 20% growth from the year-ago period.
Let me reiterate again, we are increasingly confident in our mid-term financial targets and believe the strength and stability of our annual free cash flow is an underappreciated aspect of our business. Finally, on our last earnings call, we spoke about refining our capital allocation strategy this quarter. To that point, we are pleased to announce our board of directors recently approved a new $150 million share repurchase authorization. In addition, we are committing to pursuing bolt-on acquisitions while planning to return 50% of our annual free cash flow to Knowles shareholders in the form of share repurchases.
We believe capital return will be a more recognized part of Knowles' value proposition to existing and new shareholders in the future, and also hope that this commitment serves as a strong sign of our confidence in our strategy and the bright future for our company. With that, let me turn it over to John to review our first quarter financials.
Thanks, Jeff. We reported first quarter revenues of $201 million, flat with the same period a year ago, driven by higher revenues in Precision Devices, offset by lower shipments in the Audio segment due to weak consumer electronics demand and continued supply chain shortages. Audio revenues of $146 million were down 11% from the same period a year ago, driven by a challenging supply chain and weak microphone demand in the smartphone and compute markets. The decline in MEMS microphone revenues was partially offset by increased shipments in Hearing Health on both share gains and market growth. The Precision Devices segment delivered revenues of $56 million, up 47% from prior year, driven by strong organic growth in defense, industrial, and MedTech markets, and an acquisition completed in the second quarter of 2021.
First quarter gross profit margins were 41.6%, 60 basis points above the high end of our guidance range and up 260 basis points from the same period a year ago. Audio segment gross margins improved 40 basis points over 2021 levels, driven by lower factory spending and favorable product mix, partially offset by lower factory capacity utilization in our MEMS microphone business. Precision Devices segment gross margins were 45.6%, up 920 basis points from the prior year, driven by favorable product and customer mix, productivity gains, improved factory capacity utilization, and an acquisition completed in Q2 2021. R&D expense in the quarter was $20 million, flat with the prior year.
SG&A expenses were $25 million, slightly above prior year levels, driven by the acquisition completed in the second quarter of 2021, partially offset by lower legal cost. For the quarter, adjusted EBIT margin was 19.6%, up 250 basis points from the prior year, driven by higher gross profit margins. EPS was $0.35, which was $0.04 above the high end of our guidance and $0.06 above Q1 2021, with the increase driven by higher gross profit margins and a lower effective tax rate. Now I'll turn to our balance sheet and cash flow. Cash and cash equivalents totaled $51 million at the end of the quarter. Cash from operations was $1 million, which was near the low end of our guidance range, primarily due to higher inventory levels and the timing of cash collections.
Capital spending was $7 million in the quarter, and we repurchased approximately 300,000 shares at a total cost of $6.8 million. Before moving to our second quarter guidance, as Jeff stated, the board of directors recently authorized a $150 million increase to our share repurchase program. Our strong balance sheet, coupled with our improved financial performance and strategy to focus on higher value solutions, will allow us to continue to pursue bolt-on acquisitions while planning to return 50% of our annual free cash flow to shareholders in the form of share repurchases. Moving to our guidance for the second quarter. We expect total company revenue to be between $195 million and $205 million, flat with the same period a year ago. Our revenue guidance reflects the negative impact of COVID-related lockdowns in China and continued supply chain constraints.
Revenue from the Audio segment is expected to be down 7% from Q2 2021 due to lower demand for MEMS microphones and continued global supply chain challenges, which are partially offset by increased demand in the Hearing Health market. Precision Devices revenue is expected to be up more than 20% over prior year levels, driven by broad-based strength in defense, MedTech, and industrial markets, and the acquisition completed in Q2 2021. We estimate gross margins for the second quarter to be approximately 41%-42%, down 90 basis points from the year ago period, driven by lower factory capacity utilization in our MEMS microphone business and unfavorable mix due to lower shipments to the higher margin compute market. These negative impacts are partially offset by productivity gains and improved capacity utilization in both Precision Devices and Hearing Health.
R&D expense is expected to be between $19 and $21 million, down $2 million from prior year levels due to lower incentive compensation cost. We're projecting selling and administrative expense to be between $27 and $28 million, down slightly from the year ago period, driven by lower incentive compensation cost, partially offset by the acquisition completed last year. We're projecting adjusted EBIT margin for the quarter to be in the range of 17%-19% and EPS to be within a range of $0.30-$0.34 per share. This assumes weighted average shares outstanding during the quarter of 95.7 million on a fully diluted basis. We're forecasting an effective tax rate of 12%-16% for the quarter and full year 2022.
For the second quarter, we expect cash generated from operations to be between $10 million and $20 million, and capital spending to be approximately $10 million. I'll now turn the call back to our operator to open the line for questions. Operator.
Thank you. As a reminder, that is star one if you would like to ask a question. We'll pause for a moment to compile the Q&A roster. Our first question will come from Tristan Gerra with Baird. Please go ahead.
Yeah, hi, this is Tyler on for Tristan. Thanks for taking the questions. Could you talk a little bit about the extent of disruptions you're seeing from the China lockdowns? I know you talked about it, but maybe quantify it or even talk a little more about it qualitatively, either affecting you directly or indirectly.
Yeah. I think one of the things we talked about first was supply chain. I think, you know, we've talked on previous quarters about the fact that, you know, in the first half, we were kind of held back by supply of wafers. That's still the case. That's not different than what we had said before. I would say that, you know, the thing that we're dealing with now, you know, like within China is that we have some issues in terms of shipping materials, which is causing us to take longer to get products to our customers, that's number one.
Number two, you know, some of our customers are starting to say, well, there's a little bit less that we can ship to them right now 'cause they can't get other materials, right, in order to build. I think that's probably the layer that's been added on, is that some of our customers are not being able to get all the materials that they need in order to build. The third piece, which, you know, is not necessarily supply chain related, but we are seeing, you know, that there is a definite slowdown in consumer demand in China.
I would say that's, you know, pretty broad-based at this moment that we're starting to hear that, you know, and see in terms of forecast, and it's reflected in our forecast that we're giving for Q2, that, you know, that demand is gonna be down in Q2 compared to what our expectations would have been pre-lockdown. You know, I think we are hopeful at some point the lockdowns will end, but right now, I think that's the key. I would add this, you know, our Hearing Health business, very limited impact, by what's going on with COVID, and, in terms of supply chain or demand in China. Most of our operations for Hearing Health are outside of China. Most of demand is outside of China. I would say same thing for PD.
There's a little bit more exposure for PD as we do have one manufacturing facility in China that makes up about 25% of their revenue. Overall, it's really affecting our MEMS microphone business the most.
Great. For my follow-up, is it fair to say that your defense exposure is a mid to high single digit of total revenue? Maybe if you could talk about the current geopolitical events, if they're gonna help your Precision Devices going forward.
I'm sorry, I didn't hear the second part of that.
The current geopolitical events, are they gonna benefit your Precision Devices business going forward?
Well, I don't know if it'll benefit us. I mean, I think we've already been benefiting from that. I mean, we have U.S. operations. We do a lot of work with the defense and MedTech markets. I think we've been benefiting from that already. But I think, you know, that'll be a continued benefit. As far as our defense exposure, I would say it's closer to high single digits. If I take you back to our investor deck, I believe we stated last year in 2021, it was about 10% of our revenue last year. You know, our expectations in our defense market, we are gonna have pretty good growth, which is a mixture of both organic growth as well as the acquisition, a full year of the acquisition of IMC.
Great. Thanks for taking the questions.
Our next question will come from Bob Labick with CJS Securities. Please go ahead.
Thanks. Good afternoon. Congratulations on strong operations.
Thank you.
Thanks, Bob.
You obviously just spoke about the headwinds from the impact of demand in China. One thing, you know, most of the companies we're talking to are also talking about is, you know, just the overall macro impact of inflation. What are the biggest inflationary pressures you're facing, if any, and what actions are you able to take to maintain your margins as strong as they've been?
Yeah, Bob, I can take that. It's John. You know, we have seen a significant increase in input costs. Recently, you know, the primary areas being labor costs, ASIC chips, and then certain commodities like palladium. To date, I mean, you can see in our gross margins, they're up year-over-year. We've been pretty successful in passing these cost increases onto our customers in the form of permanent price increases or surcharges. I'd say the only exception being in the area of maybe commodity microphones.
Elsewhere, you know, whether it's PD or HHT and some of the higher value solutions in mics, we've been pretty successful at passing these cost increases.
And, and let me-
You see it in our gross margin.
Let me add a little more color. You know, I think we talked about last year mobile was about, you know, 21%-22% of our sales. This year, we expect mobile to be less than 20% of our sales. You know, right now, you know, a fair amount of our commoditized mics are in that space. You know, as we've said on previous calls, you know, we're trying to reduce our exposure to commoditized mics where, you know, it's harder to pass on inflation.
Yeah, that's great. Obviously, exciting news on the capital allocation and the, you know, the repurchase authorization and the commitment to repurchase shares with 50% of free cash flow. You've been very successful in M&A in the Precision Devices market, and you said you'll still look for tuck-ins there. Can you just give us a sense of what the pipeline looks like and, you know, if you would expect to potentially have any in the next, I don't know, six to 18 months, any tuck-ins?
Well, I mean, you know, I would say that, you know, as we said in the past, specifically in the kind of PD area, it's a pretty target-rich environment. We do wanna be very disciplined in what we do here, Bob, you know, and you know, the deals that we've done for PD over the last five years, four in total, have all been extremely successful for us. I mean, whether from a financial standpoint you look at it, or from, you know, how it added to our total, whether in terms of consolidation, in some cases, addition of new products and customers, right. It's been very successful.
You know, I would sit there and say that the pipeline looks pretty good right now, and I would be hopeful over the next year, you know, we can do some more tuck-in acquisitions. You know, that being said, you know, I think when you look at our balance sheet, you know, that's why we kind of felt really strongly that we can continue to do these things coupled with return 50% of our free cash flow to shareholders in the form of share repurchases. This is not something that, you know, that it's gonna be very difficult for us to do. Because as I said on the prepared remarks, you know, we really do think it's an underappreciated portion of what Knowles does, which is generating a fair amount of cash flow.
Absolutely. Congratulations. Thank you.
Our next question will come from Christopher Rolland with Susquehanna. Please go ahead.
Thank you. This is Duksan Jang on behalf of Chris. I just wanna ask about your gross margins. They're very strong, obviously, and you talked a lot about how mix was driving this strength. As shortages are gonna alleviate over the second half and as MEMS microphones come back, how should we think about mix and margins going forward? Thank you.
Yeah. I mean, I think this is a trend that's been going on for, you know, a couple years now, which is, you know, as you see our hearing health business grow and our PD business grow, mix has been a very important piece in order towards growing our gross margins. You know, that being said, you know, I think you're right. We will have more MEMS microphone business in the back half, which is typically lower than those two other businesses. But on the other side, assuming that, you know, the market gets stronger in the back half, we'll also have better capacity utilization in the back half.
I think as I see it, and again, I'll ask John to add some color to this, is that you're gonna keep hearing from us is that if you look back to our Investor Day, the markets that are growing the fastest for us, MedTech, defense, these type of markets, both in Hearing Health, PD, EV, versus, say, mobile is generally a flat to down market in terms of the end market. Plus, we're trying to walk away from commoditized microphones. I think mix will continue to be a big strong driver for us in the future in order to get to that kind of midterm goal we laid out of 43%.
Yeah. I mean, just kind of along the same lines of what Jeff just mentioned. I mean, the themes related to our gross margin expansion that we've realized over the last several quarters, they're really unchanged as we continue to benefit from mix shift, from a higher proportion of sales coming from PD, HHT, and high-value MEMS microphone solutions. You know, I'm not giving guidance for the second half of the year, but we do expect full year gross margins to be higher than they were in 2021.
Got it. Thank you. You also mentioned that there are new products coming in the second half, and that also tends to be a seasonally stronger period. Do you have enough supplies coming online to support that growth? Because I think you said wafer shortages are still ongoing and impacting the June guide. Thank you.
Yeah, again, I'll take you back to. It's very similar to what we said before. I think in total, even in the first half, we were getting enough wafers in total, but the mix was wrong. In other words, we had excess capacity or availability of wafers at certain fabs and not enough at another. I think in the short term, it's very hard to change that when I say from one fab to another. In the longer term, as we introduce new products and our customers introduce new products, it gives us an opportunity to bring in a new wafer supplier where we have more demand.
Our hope is that we look toward the back half of the year, we'll be better aligned in terms of where we have capacity at our wafer suppliers relative to where our demand is.
Thank you.
Thank you.
As a reminder, that is star one if you would like to ask a question. Our next question will come from Suji Desilva with Roth Capital.
Hi, Jeff. Hi, John. Hi.
Hi, Suji.
Hi, Jeff. Hi, John. Just trying to understand, you know, given the demand softening a bit, can you articulate either in numbers or qualitatively how much of your microphone segments are China versus non-China if you go smartphone versus your IoT component? And I mean sort of end customer demand. Do you have a sense?
Yeah. I would sit there and say, you know, I mean, this is kind of a broad statement, but, you know, in our MEMS microphone business, demand is down across all of our kind of like segments, right? You know, in terms of when you say mobile, our IoT for China, right? With the overall backdrop, I think we predicted this, that the laptop compute market was gonna be soft Q1 into Q2, and we're thinking starting to recover in Q3. That's a global phenomenon, I think more of the laptop business. You know, I think, you know, what we've seen is in March a pretty abrupt, you know, reduction in forecast from our customers, that. Well, what do you call it?
That is across the board in terms of consumer electronics. Now, you know, again, it's hard to say what's gonna happen through the quarter, how all these lockdowns are gonna go, but the bottom line is, you know, I keep coming back to this. We still expect revenue growth this year. We still expect earnings growth this year, you know, as we continue to focus, you know, on moving towards higher value, higher margin portions of our business.
Okay. As you look ahead to the second half, maybe what segments or sub-segments do you have some of the most optimism about in terms of helping drive growth or recovery?
Yeah. I mean, I think, you know, if I look at our PD business continues to look very strong. I mean, I mentioned this on my script, in my prepared remarks in the press release. You know, we had another quarter of record just blockbuster bookings in PD. You know, and I just, we're very bullish on this because, you know, a lot of people would say, "Are these bookings like things that could be canceled later, you know, relative to the fact that, you know, there might be people over ordering?" And I'd say the answer for the vast majority of the bookings are not. These are custom products that are built either for markets like the defense or the medical market, where we see the demand.
I feel very good about the PD business.
I'd just add too, Suji, I mean, our biggest challenge in PD is increasing output.
Yeah.
You know, we're working to increase output sequentially from Q2 to Q3 to Q4.
Correct.
-based on this backlog.
Correct. You know, again, this, we don't feel like this is, you know, turn's business that could disappear, you know, if the market weakens.
Mm-hmm.
This is like real demand. You know, in our Hearing Health business, you know, the demand remains robust. I think you know I always say this that the team, they've done an excellent job of executing on new products, coupled with they've really minimized the supply chain issues, you know, in terms of during this kind of ramp up from when the Hearing Health business was affected by COVID, you know, back in 2020. The demand looks robust. We gotta obviously continue to monitor that, but the Hearing Health business looks robust. I think on the MEMS microphone business, I think it's a little more wait and see, like how these speed lockdowns develop.
I mean, it's you know, I think it's factored into our numbers for Q2, but we'll have to see how this all develops, as the rest of the year goes by. I think from my perspective, Suji, is I feel like, you know, we're still increasing our operating margins. We're increasing our EPS. This is a really good story that says that, you know, when we get back to growth in our MEMS microphone business, you can really see the power that's gonna come in this business in terms of profitability and also cash flow.
Okay, great. Thanks, guys.
Yep.
There are no further questions. That will conclude today's call. Have a great evening, and thank you for your interest in Knowles.