Methode Electronics Inc Q1 FY2024 Earnings Call

Greetings and welcome to the Methode Electronics First Quarter Fiscal 2024 Results Call. At this time, all participants are in listen-only mode, and a question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Robert Cherry, VP of Investor Relations. Sir, you may begin.

Thank you, operator. Good morning, and welcome to Methode Electronics' fiscal 2024 first-quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2024 first quarter financial results, which can be viewed on the webcast of this call or found at methode.com on the Investors page. This conference call contains certain forward-looking statements, which reflect management's expectations regarding future events and operating performance and speak only as of the date hereof. These forward-looking statements are subject to the Safe Harbor protection provided under the securities laws. Methode undertakes no duty to update any forward-looking statement to conform the statement to actual results or changes in Methode's expectations on a quarterly basis or otherwise. Forward-looking statements in this conference call involve a number of risks and uncertainties. The factors that could cause actual results to differ materially from our expectations are detailed in Methode's filings with the Securities and Exchange Commission, such as our 10-K and 10-Q reports. At this time, I'd like to turn the call over to Mr. Don Duda, President and Chief Executive Officer.

Thank you, Rob, and good morning, everyone. Thank you for joining us for our fiscal 2024 first-quarter earnings conference call. I'm joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I will have opening comments and then we will take your questions. Let's begin on slide four. Our sales for the quarter were a solid $290 million. They were up 3% compared to the prior year, mainly due to $21 million in sales from the acquisition of Nordic Lights. Excluding Nordic Lights, foreign exchange, and a significant drop in customer-reimbursed material spot buy and premium freight cost recovery, sales were down 2%. The decrease was mainly due to lower sales in our auto segment, which was partially offset by higher sales in the industrial segment driven by lighting solutions for commercial vehicles. With the addition of working lives from Nordic and the ongoing contribution from our existing interior and exterior lighting solutions for commercial vehicles and automotive, Methode is clearly building a lighting solutions franchise that complements our growing business and power distribution solutions. In the quarter, we experienced very significant operational challenges. Operational inefficiencies in our North American auto operations were caused mainly by personnel turnover, poor operational decisions, and vendor issues, which led to subsequent production planning deficiencies. This created a domino effect leading to inventory shortages, unreimbursed spot purchases, premium freight, and some delayed shipments. While the full picture is nuanced, I can share with you the essence of what occurred. Our Monterrey operation has historically manufactured with a low mix and a high volume of products. Recently, the operation has transitioned into a mode of higher mix and lower volume. This transition combined with the aforementioned issues led to the exposure of late operational inefficiencies that our early warning system detected, but we failed to mitigate in a timely manner. In a lean manufacturing environment, a delay in visibility of a problem can ultimately generate significant costs in the form of premium freight and spot buying, both necessary to immediately address material shortages and maintain customer delivery integrity. In auto, delivering in addition to quality is absolutely paramount to both maintaining and obtaining new business. These operational challenges had approximately a $0.15 impact on our first quarter earnings relative to our expectations. We also had accelerated expenses related to numerous program launches. I can confidently tell you these operational challenges have been identified and corrective action plans are already in place, including the hiring of seasoned planners in the U.S. However, the residual effects are expected to impact our second quarter to approximately the same degree, coupled with a significant weakening of the e-bike market, which are the primary drivers for lowering our earnings guidance for the full year. As I've said, this was very significant and I have been and will continue to be personally involved with the efforts to correct the situation. On that, you have my personal commitment as CEO and as a shareholder, we will fix this. Moving to orders, we had a solid quarter with over $70 million in annual program awards. These programs were once again led by electric vehicle programs. Turning to Medical, after pursuing multiple strategic avenues for Dabir including everything from a formal sales process to the continued operation of the business, it became abundantly clear that discontinuation was the best financial path forward. I want to thank the Dabir and Methode employees associated with the business for all their efforts, as well as the customers who provided the opportunity to market the Dabir product. Turning back to EV activity, sales in the quarter were 22% of our consolidated total. In new awards, we won over $30 million in annual EV programs for fiscal 2024, and while activity will be strong, it will still be very dependent on OEM take rates as well as the timing of program roll-offs. In the quarter, we had an increase in debt driven by working capital investments to support our sales and program launches; while our debt and consequently our leverage has increased, it is still relatively low. As such, we are very comfortable with our flexibility for capital deployment, whether it's for internal investments, share buybacks, or additional acquisitions. As is typical in our first quarter due to payments for year-end items with negative cash flow in the quarter, however, we fully expect to return to positive free cash flow in the second quarter and have meaningful positive free cash flow for the full year. Moving to slide five, the awards represent some of the key wins in the quarter and translate to $70 million in annual sales at full production. The launch timing of most of these programs could be anywhere from one to three years from now. The awards are mainly for power products associated with the EV skateboard architecture, and we have also been awarded programs for lighting solutions in auto and sensor solutions for e-bikes, although those won't launch until fiscal 2026. In summary, sales in the quarter continued to be solid, particularly for EV applications. The Nordic Lights integration is progressing well, and we expect to own 100% of the shares by the end of the second quarter. The program awards pipeline continues to be healthy, especially in EV. Lastly, the quarter included unacceptable lapses in operational efficiency; my immediate focus, as well as the entire management team's focus, is on correcting those inefficiencies. As I have stated, the operational issues have been identified, and corrective actions are underway. We will also continue to focus heavily on executing our new program launches. Looking ahead, due to program roll-offs and the expected weakness in key markets, especially e-bikes, we expect low organic sales in fiscal 2024. Additionally, we will be making significant investments in launching over 20 new programs. These investments involve significant tooling and increased staffing to ensure a successful 2025. This, along with multiple years of strong awards, is expected to enable us to not only replace the sunsetting programs but to grow the business organically by 12% from fiscal 2024 to fiscal 2025. Our view on fiscal 2025 has not changed. This guidance demonstrates that our business model is healthy and is positioned to prosper from the strategic direction that we have taken towards lighting and power solutions to grow the business. Before I conclude, I would like to address the recent announcement of my retirement. Leading Methode has been a tremendous personal and professional journey for me, and I am incredibly proud of all that our team has achieved to grow the company. Having served 19 years as CEO, it is simply time for me to step down and enable the next successful stage of the Methode journey to begin. I am extremely confident that the company will continue to flourish given the exceptional team in place and a solid strategy that is positioned for growth. I truly believe that Methode's brightest days are still ahead. Meanwhile, I will continue to actively lead the company until a successor has been named and then I will work with the new CEO through an extended transition period, which is expected to conclude sometime in fiscal 2025. At this point, I will turn the call over to Ron, who will provide more detail on our first quarter financial results as well as more details on our outlook.

Thank you, Don, and good morning, everyone. Please turn to slide eight. First quarter net sales were $289.7 million compared to $282.4 million in fiscal '23, an increase of 2.6%. This quarter's sales included $21.2 million from the Nordic Lights acquisition and $0.5 million from favorable currency translation. Partially offsetting those positive impacts was $10.4 million lower in spot buy and premium freight cost recovery. Excluding Nordic Lights, foreign currency, and the year-over-year cost recovery impacts, sales decreased by 1.5%. In addition to Nordic Lights, this quarter's ongoing strength in lighting solutions for commercial vehicles, we also saw the continuation of a large program roll-off in North America. First quarter income from operations decreased 82.6% to $3.8 million from $21.8 million in fiscal '23, mainly due to operational efficiencies, higher S&A expenses, and an unfavorable product sales mix. Adjusting for net acquisition costs of $0.8 million related to Nordic Lights and restructuring costs related to the exit from Dabir of $0.7 million, our non-GAAP adjusted income from operations decreased 75.7% to $5.3 million from $21.8 million in fiscal '23. Please turn to slide nine. First quarter diluted earnings per share decreased 96.6% to $0.02 per share from $0.58 per diluted share in the same period last fiscal year. The EPS was negatively impacted by operational inefficiencies, an unfavorable product sales mix, higher professional fees, the absence of government assistance, and higher net interest expense. Adjusting for net acquisition costs of $0.6 million and restructuring costs of $0.5 million, our non-GAAP adjusted diluted EPS decreased 89.7% to $0.06 from $0.58 per share in fiscal '23. Shifting to EBITDA, a non-GAAP financial measure, first quarter EBITDA was $17.8 million versus $38.2 million in the same period last fiscal year, representing a 53.4% decrease. EBITDA was negatively impacted by higher operational costs, an unfavorable sales mix, higher SG&A expenses, and the absence of government assistance. The contribution from Nordic Lights helped to partially offset the decrease. Adjusting for acquisition costs of $0.8 million and restructuring costs of 0.7%, our adjusted EBITDA decreased 49.5% to $19.3 million from $38.2 million in fiscal '23. Please turn to slide 10. We increased gross debt by $32.2 million in the quarter, mainly due to working capital investments and higher CapEx both to support sales and new program launches. We ended the quarter with $147.9 million in cash, down $9.1 million from the end of last fiscal year. Net debt, a non-GAAP financial measure, increased by $41.3 million to $191.1 million for the quarter from $149.8 million at the end of fiscal '23. Again, the main driver of the increase was working capital and CapEx. Our debt to trailing 12-month EBITDA ratio was approximately 2.7 times; our net debt to trailing 12-month EBITDA ratio was approximately 1.5 times. Please turn to slide 11. First quarter net cash from operating activities experienced an outflow of $5.6 million as compared to an inflow of $12.7 million in fiscal '23. The decrease of $18.3 million was primarily due to lower net income in the quarter. First quarter capital expenditure was $13.8 million as compared to $9.6 million in fiscal '23, an increase of $4.2 million. This increase was mainly a function of investments to support new product launches and was in keeping with our guidance. First quarter free cash flow, a non-GAAP financial measure, was a negative $19.4 million as compared to a positive $3.1 million in fiscal '23, a decrease of $22.5 million. This decrease was primarily due to reduced net income and increased CapEx. Please turn to slide 12. Regarding forward-looking guidance, it is based on management's best estimates and subject to change due to a variety of factors as noted on this slide. The operational inefficiencies experienced in the first quarter will carry over to the second quarter. The impact on EPS in the first quarter was approximately $0.15, and we expect a similar impact on EPS in the second quarter. In addition, we expect to experience a decrease in sales volume relative to our original expectation and increased legal and professional fees. Given the short headwind, we are providing guidance for the second quarter. The expected net sales range for fiscal '24 second quarter is $285 million to $295 million. The expected diluted earnings per share range is $0.08 to $0.13. Adjusting for $0.04 of costs related to the Dabir exit, we expect the adjusted diluted earnings per share to be in the range of $0.12 to $0.17. Turning to the full year, the expected net sales range for fiscal '24 is $1,140 million to $1,180 million. Full-year sales guidance was decreased by $15 million at the midpoint, mainly due to the softening of sensor sales in the second half of the fiscal year. The expected diluted earnings per share range is $0.80 to $1.00, down from a previous range of $1.55 to $1.75. The drop is predominantly related to the operational inefficiencies in North America and the auto sector being experienced in the first and second quarters, along with a significant slowdown in our sensor business in the second half of the fiscal year. Our sensor business enjoys gross margins well above the consolidated level. Adjusting for $0.06 of costs related to the Dabir exit and $0.02 related to the Nordic Lights acquisition, the expected adjusted diluted earnings per share range is $0.88 to $1.08. The fiscal '24 guidance assumes an income tax rate of 14% to 16% with no discrete tax benefits or expenses. It assumes CapEx of $60 million to $70 million and assumes depreciation and amortization of between $55 million and $60 million. Looking ahead to fiscal '25, the expected net sales remains unchanged at $1,250 million to $1,350 million. The midpoint of that range represents a 12% organic sales growth from the midpoint of the fiscal year '24 net sales guidance range. The expected range of income from operations as a percentage of net sales in fiscal '25 is also unchanged at 11% to 12%. The fiscal year '25 income tax rate is expected to be between 20% and 22% with no discrete tax benefits or expenses. Don, that concludes my comments.

Ron, thank you very much. Operator, we are prepared to take questions now.

Thank you. At this time, we'll be conducting a question-and-answer session. Thank you. Our first question is coming from Luke Junk with Baird. Your line is live.

Hi, good morning. Thanks for taking the questions. I want to start this morning with the labor and vendor issues in auto that you saw. What I'm just wondering is to what extent you had a line of sight or not when you last gave guidance in late June and how that lines up with what you're now anticipating in the business, especially your confidence that the corrective actions you've taken will be a sufficient offset in the second half, what would be the risks that is not the case further if the action doesn't have the expected benefit? Thank you.

Through the first two months of the quarter, we were pretty much on track. Now, when we go back and do a postmortem on it, there were indeed issues. Yes, the magnitude of the inbound and outbound freight really didn't become apparent until July, and once you start to air freight product, the costs go up dramatically. That's the main driver of our miss. Confidence, we know this will carry into the second quarter. We've dropped the inventory levels, and we need to replenish some of that. We will still have premium freight both inbound and outbound this time. What's my confidence level? High! I wouldn't have said what I said in my prepared remarks if I didn't feel confident we could fix that. It's very disappointing, but we're a seasoned management team, and the plant has transitioned from high-volume to lower-mix products, which they did very well producing. To a high-mix lower volume, and we've had some issues with that coupled with employee turnover, some voluntary and some involuntary. We are correcting some decision-making, and I am confident of that. We're known for our operational excellence, and we will correct this.

Thanks for that, Don. Second, hoping you could comment on where price cost is in the business today. Some incremental inflation was mentioned in the release. And just the status or tone of your conversations with customers recovery is fairly modest here in the first quarter. Should we expect that to accelerate as we go through the balance of the fiscal year?

That's always a double-edged sword for us. We've had very difficult discussions with our customers. Some of this is not with us, but some has been in the past where the automakers are getting tougher on price concessions. This will be a struggle going forward. Now, where we've turned our attention is our Purchase Price Variance which has been negative for the last couple of years. We feel that with our growth, we can put pressure on our suppliers or seek out other suppliers. Although I will tell you, one of the issues we had in our Monterrey plant was changing suppliers; that must be done carefully. We'll continue to pressure customers for price increases, but I'm not going to destroy the relationship. We tread lightly there, especially since we have only so many automakers to work with. However, I'm confident our team has done well in pushing this. Our focus will be on factory efficiencies and improving that while also putting more pressure on our vendors. This approach should yield better results than jeopardizing customer relationships. As we launch these new programs, particularly in Monterrey, we will achieve more overhead coverage going forward.

From the procurement side, even though we've had supply challenges and had to manage premium freight, that was more of our missteps than anything. I think you're going to see a pivot towards emphasis on procuring supplies, which was challenging over the past couple of years, but is beginning to stabilize. We will focus on getting that positive Purchase Price Variance and return to more historical standards.

We didn't build it into this year's guidance. We've had all of our teams look at areas where we can economize on purchasing, and we put one of our seasoned VPs on it. What I've seen on paper gives me confidence that as we go into '25, we will definitely see improvement, not just from the overhead coverage but also from Purchase Price Variance.

For my last question, just the bigger picture. I hope you could expand on the implications of the decision to wind down the Dabir business. Specifically, if you have any interest in medical going forward overall, and to what extent are the costs affecting the P&L?

That decision was one of the toughest I've made in my career. The amount of orders that we received from customers, no one wanted to see it discontinued; it was an indication that it was well received. It was just very difficult for us to scale. It definitely helps people; it saves money. However, it is hard and expensive to scale. We considered seeking external funding, but it ultimately was not where we should be spending our time. We focused on three areas: medical, EV, and sensors. The medical route did not yield the necessary management commitment time, so it was time to concentrate on the other two areas, and we continue to book business there. We conducted a formal sales process; we sent out feelers to 70 companies and received 30 responses, but there was no interest in continuing the business. Given the scale and struggles in hospitals, it was time to discontinue.

Got it. That's all helpful. Thank you. I'll leave it there.

Yes. I think, Luke, if I could have seen our way to breakeven, I would have taken a different approach, but it literally would take us another five years to reach that point, and again I don't think that's where Methode should be focusing its assets.

Thank you. Our next question is coming from John Franzreb with Sidoti and Company. Your line is live.

Good morning, guys, and thanks for taking the questions. I wanted to go back to the EPS revision. You pulled it down more than the implied $0.15 last quarter and expected this quarter from the production and labor disruptions. What is the balance of you pulling down that number?

The lower EPS is mainly driven by operational efficiencies and product mix, which are the two main drivers.

Are you referring to the full-year or a quarter?

Full year.

Yes, the operational inefficiencies account for about $0.30, and the product mix is largely due to the e-bike and sensor markets. The lower organic volume is also a contributing factor.

Those three areas account for our most profitable products. The e-bike market is seeing over-inventory for the duration of the year and heading into next year as well. We've studied the e-bike market and concluded a significant inventory issue has arisen, which necessitated our guidance revision.

Okay. Just a couple of things based on your answers. Can you give us context of how much revenue e-bikes contributed on a quarterly peak and what they are contributing today?

At its peak, e-bike revenue contributed about 50%.

And do you think you can sustain revenue in 2025 of about what for e-bikes?

Around 40%.

Okay. Alright. Just trying to get the context of that business and how it's impacting everything. You also mentioned data centers as one of the reasons for pulling down guidance. Has demand for data centers weakened from your perspective since last quarter? Most companies I follow in the data center sector are posting good results. There seems to be a disconnect with what you're seeing.

Our major customer there has told us that they are over-inventoried. So, it’s not the market as a whole. Our significant client has informed us of their situation, which is causing us to adjust our expectations.

Okay. Alright. And switching off that on SG&A expenses, I know you mentioned other fees in there. What would be a normalized SG&A run rate for the second half of the fiscal year? What are your expectations?

We would expect it to be less than 17.3%. If we exclude amortization, it will be in the range of 11% to 12%, depending on various factors.

Okay. And that reflects Nordic, I'm assuming, right?

Yes, the first quarter numbers of 17.3% and 15.4% without amortization from Nordic Lights, correct.

Right. Right. Okay. That's all I had. I'm going to jump back in the queue and let somebody else ask the questions. Thank you, guys.

Thank you.

Our next question is coming from Gary Prestopino with Barrington Research. Your line is live.

Hi, good morning, everyone.

Good morning.

I want to drill down on what you were talking about in your Monterrey, Mexico facility. You were basically producing center consoles there, right? That was one of the bigger products. And I think that business has gone away because the model is going away. Is that correct?

Right. Center consoles are not being utilized in vehicles anymore, at least not in the vehicles we are servicing; pickup trucks and SUVs are transitioning towards discrete touch screens. Those products have reached their end of life, not only for us but industry-wide. We also had a lead frame for transmissions that was a significant volume product as well. That too has seen decreased demand but has not gone entirely end of life. These products have been replaced by smaller volumes and while I say smaller, I mean in the range of 300,000 to 400,000 units. It is not a million, that's why we're talking about the transition here.

Okay. So, this is Monterrey, Mexico; was there a Mexican national running that plant? Or did you have someone from the U.S. doing that?

What we've done is bring in one of our most seasoned operations leaders to oversee the plant. He is mainly from the U.S. but has significant experience and will train other individuals to run the plant. So he is not a small national but his experience will aid greatly, and that gives me confidence that these issues will be behind us.

Well, I guess the question I would have is that out of the plant, can you replace the sales that you've lost from these programs that are going end of life or slowing down to the point where you get some kind of equilibrium or even growth by the progress or whatever we're producing on smaller volumes?

Yes. A lot of the EV business we have won is launching out of Monterrey. The team there has previously manufactured those products, so I'm very confident that their business will uptick. While I'm not happy with the current state, I'd much rather face this issue now than during the ramp-up in 2025. So, that plant will indeed experience more volume than it had even during the center console era.

Okay. But a lot of what happened there was really an operational issue in terms of just the efficiencies at the plant caused by the shift from high volume to low-volume mix, I mean that's kind of the sense that I have.

No, not at all. I take some comfort in the fact that we had good sales, but the operational execution issues are internal challenges that we created and can fix. Yes, in e-bikes, I would love to sell more sensors, but I can't do much about external market conditions. I can, however, address and rectify the factory's issues, which I view as a comfort.

Alright, thank you very much.

Thank you.

Thank you. Our next question is coming from John Franzreb with Sidoti and Company. Your line is live.

Yes, I think we kind of avoided touching on the Class A truck market today. It seems that ACT has been narrowing expectations of the depth and duration of the potential downturn in the Class A trucks. What are your thoughts about that market? Are you more bullish or bearish considering current ACT trends?

We haven't seen an increase, but it hasn’t decreased significantly beyond what was predicted. I'm not entirely comfortable saying it will not go down, but I think they mentioned a 1% expectation reduction. Our view is it may dip below average but could also recover faster, which gives me additional comfort for '25. I'm less concerned than I was a quarter ago if that provides any clarity.

Yes, it actually does. It makes sense to me. Okay, alright, thank you. Thanks for taking my question.

And Gary, I need to apologize for mistakenly calling you John at the close of your questions. I sincerely apologize.

It's okay.

Thank you. We have reached the end of our question-and-answer session. So, I will now hand it back to Mr. Duda for any closing remarks.

Thank you, operator, and thank you all for joining us today. Have a great day.

Thank you. This concludes today's conference, and you may disconnect your lines at this time. We thank you for your participation.