Earnings Call Transcript - MEI Q2 2025

Operator, Operator

Greetings, and welcome to the Methode Electronics Second Quarter Fiscal 2025 Results Call. At this time, all participants are in a 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, Vice President of Investor Relations. Sir, the floor is yours.

Robert Cherry, Vice President of Investor Relations

Thank you, operator. Good morning, and welcome to Methode Electronics Fiscal 2025 Second Quarter Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2025 Second 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. The 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-Q and 10-K reports. On Slide 4, please see an agenda for our call today. We will begin with the business update, then a financial update, followed by a Q&A session. At this time, I'd like to turn the call over to Mr. Jon DeGaynor, President and Chief Executive Officer.

Jonathan DeGaynor, President and CEO

Thanks, Rob, and good morning, everyone. Thank you for joining us for our second quarter earnings conference call. I'm joined today by Laura Kowalchik, our Chief Financial Officer. We are pleased to have Laura join the Methode team given her background and experience. She has an impressive track record of delivering successful business transformations within our industry and has gotten off to a fast start at Methode. Turning to Slide 5 and our results for the quarter. Our sales were $293 million, and our adjusted pretax income was $9 million. As noted in our earnings release, the quarter benefited from an extra week. Our fiscal 2025 is a 53-week year, and that extra week fell into this quarter. Aside from the impact of the extra week, sales benefited from higher demand from our Power Products in data centers and electric vehicles. We also had growth in Europe from automotive program launches. Offsetting these strengths were program roll-offs that we discussed before and demand weakness in the commercial vehicle market impacting our lighting business. Overall, our sales in the quarter were on track with our expectations. The solid sales volume, along with progress on our cost reduction efforts, drove the pretax income improvement in the quarter. In particular, we had a notable reduction in freight costs, particularly premium freight, which is a direct reflection of our overall improved operational execution. The better-than-expected result was also driven by improved fixed overhead absorption, another sign of execution improvement. Turning to EV activity. Sales in the quarter were 20% of our consolidated total, a sequential increase from 18% in the first quarter. We are experiencing the beginning of a wave of new program launches for EV power applications. As such, we continue to expect the EV percentage to grow further, and it should be over 20% for our full year fiscal 2025. While our sales are currently on track for the full year, there are clearly some tailwinds and headwinds in several of our key end markets. Helping us is the growth in data centers. Conversely, hurting us is the weakness in automotive and commercial vehicle demand. The EV market has clearly softened, particularly in North America, but our program launches are mitigating that softening. Turning to the balance sheet. We are maintaining an acute focus on managing it and generating cash. While we experienced a timing issue with accounts payable this quarter that led to a sizable reduction of net cash from operating activities, we were comfortably in full compliance with all our debt covenants. On the order front, we had another solid quarter with over $50 million in annual program awards. This is on track with our expectations for the year. The pipeline of bookings is subject to reduction and/or delay due to customer decisions and/or market conditions. Lastly, and as I have emphasized before, our immediate priority is to successfully execute on the large pipeline of new programs that must be launched in the next 18 months. In fiscal 2025, we have over 30 program launches. And in fiscal 2026, we have another 20-plus programs to launch. Our customers are counting on us, and we plan to deliver. In short, we believe that our efforts to improve our execution have started to bear fruit as clearly evidenced by the better-than-expected results in the quarter. Turning to Slide 6. The awards identified here are some of the key wins in the quarter and represent $43 million of annual sales at full production. As usual, the launch timing of these programs could be anywhere in the range of one to two years from now. All of these awards were for power distribution products for applications in EV, traditional auto and defense. As you can see from this chart, bookings can be lumpy. What's important to note is that on a trailing 12-month basis, we are winning awards at a rate sufficient to at least maintain our current annual sales level. Overall, we feel our award activity has been solid. Turning to Slide 7. One of my learnings since taking the CEO role in July is that the company's path to success relies on returning to a One Methode mindset, where all our global teams are working together and moving in the same direction. This mindset existed within Methode historically and needed to be reinvigorated. To facilitate this reinvigoration, we have made a couple of key executive moves. We've appointed a dedicated leader that will oversee all global strategic launch and commercial activities for the company's Automotive business. On December 2, Lars Ullrich joined Methode as Senior Vice President, Global Automotive business, reporting directly to me. Lars comes to us with over 20 years of business and strategic leadership experience in multinational companies, mainly at suppliers like Infineon and Robert Bosch. During his career, he has built a reputation for strategic and innovative thinking, a collaborative approach to customer relationships, operational excellence and clarity in the face of challenges. He will be a strong addition to our leadership team and help us to develop and launch programs that delight our customers. In addition, we have also promoted Sadek El Idrissi to lead all operations and engineering in Europe and the Middle East. This will be in addition to his current responsibilities as our Vice President of China. In his 18-year career at Methode, he has held management roles of increasing responsibility culminating with the successful execution of the company's strategy in China. Sadek is well respected and his experience, leadership and demonstrated ability to achieve results makes him an ideal leader to guide our European and Middle Eastern operations through a challenging period of growth. These are both initial but crucial steps to getting back to our history, operating as One Methode to drive success. And with these steps, we now have fresh perspectives in the roles of CEO, CFO, CPO and SVP of Global Auto as compared to just five short months ago. Turning to Slide 8. In summary, for the quarter, sales were on track, while our pretax income was better than expected. EV activity steadily grew and was 20% of total sales. Data centers were a market tailwind, but the auto and commercial vehicle markets were a concern. While we experienced a timing issue on cash, we were comfortably in full compliance with all debt covenants. Lastly, program awards were solid. Going forward, our focus this fiscal year is to transform the business while positioning it to return to profitable growth next fiscal year. Meanwhile, we are focusing intensely on executing our 30 programs while taking decisive actions to address execution and costs. Led by our new leadership team that we have systematically built over the last several months, Methode is focused on transforming its business. We are also committed to compliance and taking steps to invest in our compliance resources and processes. Regarding compliance, Methode has disclosed that the company has received a subpoena from the SEC, seeking documents and information. We take all compliance matters seriously and are cooperating fully. While we are limited in what we can say about this matter, we are committed to transparency. We'll keep you informed. Lastly, for fiscal year 2025, we are reaffirming guidance for flat sales and raising adjusted pretax income guidance to approximately breakeven. I've spent a tremendous amount of time traveling over the past quarter, meeting with customers, visiting our plants and talking to Methode employees. I can share with great confidence that our team is clearly energized and the results from this quarter demonstrate that our business is heading in the right direction. At this point, I'll turn the call over to Laura, who will provide more detail on our second quarter financials.

Laura Kowalchik, Chief Financial Officer

Thank you, Jon, and good morning, everyone. I am very excited to join the Methode team, and thanks to Jon for his kind remarks. Please turn to Slide 10. The second quarter net sales were $292.6 million compared to $288 million in fiscal 2024, an increase of 2%. On a sequential basis, sales increased 13% from the fiscal 2025 first quarter. As Jon referenced, the company's typical fiscal year is 52 weeks, but occasionally requires an additional week in order for the fiscal year to end on the Saturday closest to April 30. The current fiscal year ending May 3, 2025, is a 53-week fiscal year with the additional week being included in this fiscal quarter, making it a 14-week period. The prior year second quarter as well as this year's first quarter were 13-week periods. As a result, the extra week contributed to our financial comparisons. In this quarter, sales of Power Products into data center applications grew both year-over-year and sequentially. We also saw some modest growth in EV sales sequentially. The quarter also benefited from our launch activity in Europe. Offsetting those strengths was the impact of the previously disclosed roll-off of an EV lighting program in Asia. That program ended toward the end of the last fiscal year and has had no sales this year. Also creating a headwind was the market weakness for our lighting products in commercial vehicle and off-road applications. First quarter adjusted income from operations was $14.3 million, up $8.3 million from fiscal 2024. On a sequential basis, adjusted income from operations improved $19 million from the fiscal 2025 first quarter. Please see the appendix for a reconciliation of all adjusted measures to GAAP. The increase in adjusted operating income, both year-over-year and sequentially, was driven by the higher sales volume. In addition, we were able to significantly reduce our freight costs, particularly our premium freight due to the operational improvements that Jon described. The increased volume also served to improve our fixed overhead absorption. Overall, our second quarter sales were on track with our full year expectations. Please turn to Slide 11. Shifting to EBITDA, a non-GAAP financial measure. Second quarter adjusted EBITDA was $26.7 million, up $5.5 million from the same period last year. On a sequential basis, adjusted EBITDA improved $16.9 million from the fiscal 2025 first quarter. The adjusted EBITDA benefited both year-over-year and sequentially from higher sales and gross profit. It was also driven by lower selling and administrative expenses in both comparisons. Please turn to Slide 12. Second quarter adjusted pretax income was $6.2 million, up $3.8 million from fiscal 2024. On a sequential basis, adjusted pretax income improved $15.3 million from the fiscal 2025 first quarter. Compared to the prior year and the last quarter, adjusted pretax income was driven by higher net sales. In addition, both comparisons benefited from lower freight, while being partially offset by higher net interest expense. Second quarter adjusted diluted earnings per share increased to $0.14 from $0.06 in the same period last fiscal year. On a sequential basis, the adjusted earnings per share increased $0.45 from the fiscal 2025 first quarter. The second quarter adjusted EPS included a tax expense due to the GILTI tax treatment on foreign earnings, which was offset by various tax benefits. The result was approximately 0 adjusted tax expense in the quarter. Overall, our second quarter adjusted pretax income was slightly ahead of our full year expectations. Turn to Slide 13. Debt was up $9.7 million from the prior year-end. We ended the quarter with $97 million in cash, down $64.5 million. Elevated program launch activity drove higher inventory investment year-to-date. This was the primary use of cash year-to-date. Net debt, a non-GAAP financial measure, increased by $74.2 million to $243.6 million. The increase was mainly due to the aforementioned use of cash. Despite the consumption of cash, we were in compliance with all of our debt covenants at the end of the second quarter. Please turn to Slide 14. The second quarter's net cash from operating activities was a negative $48 million as compared to a negative $0.6 million in fiscal 2024. The decrease of $47.4 million was primarily due to a sizable decrease in accounts payable related to the timing of payments between the first and second quarter as well as the 14-week period. Second quarter capital expenditure was $10.4 million as compared to $10.7 million in fiscal 2024, a slight decrease of $0.3 million. Second quarter free cash flow, a non-GAAP financial measure, was negative $58.4 million as compared to a negative $11.3 million in fiscal 2024, a decrease of $47.1 million. This decrease was mainly due to the accounts payable timing issue that I just described. Please turn to Slide 15. Regarding forward-looking guidance, it is based on management's best estimates and is subject to change due to a variety of factors as noted at the bottom of this slide. For fiscal 2025, we are reaffirming expected net sales to be similar to fiscal 2024 with the third quarter expected to be similar to third quarter of fiscal 2024. We are raising adjusted pretax income guidance to be approximately breakeven. This raise is mainly a function of our outperformance in the second quarter. Please note that the adjusted pretax income in the fourth quarter is expected to be significantly stronger than the third quarter with the third quarter potentially having a pretax loss. Please keep in mind that our third quarter is historically our weakest quarter due to the holidays and customer shutdowns. In addition, it will be our first full quarter since the effective end of the GM T1 program, and we are also seeing some near-term auto market weakness just like others in the industry. This fiscal year 2025 guidance assumes depreciation and amortization of $60 million to $65 million, CapEx of $45 million to $55 million, and tax expense of $13 million to $15 million. The reduction in CapEx guidance is primarily related to the lower run rate year-to-date. The increase in tax guidance is related to a higher valuation allowance for U.S. deferred tax assets, which was $7.5 million through the first half of the year. Looking further ahead to fiscal 2026, we are reaffirming expected net sales to be greater than fiscal 2025 and pretax income to be positive and notably greater than fiscal 2025. That concludes my comments, and we can open it up to questions.

Operator, Operator

Thank you. At this time we will be conducting a question-and-answer session. Our first question is coming from John Franzreb with Sidoti & Company. Your line is live.

John Franzreb, Analyst

Good morning, everyone, and thanks for taking the questions. I was wondering if you could quantify the impact of the extra week, not only on the top line, but perhaps on operating results.

Jonathan DeGaynor, President and CEO

So John, from what we look at with the extra week is it's approximately $20 million worth of revenue. And then it would have the follow-on operating results that go along with that.

John Franzreb, Analyst

Okay. Those drop down. Got it. And what cost control measures impacted the second quarter results beyond the reduction in freight costs? Was there anything else that had a positive impact on operating income?

Jonathan DeGaynor, President and CEO

Yes. We are noticing a reduction in overheads and an improvement in our scrap activities. The execution-driven initiatives are truly enhancing our performance.

John Franzreb, Analyst

Okay. Fair enough. And of the $50 million in new orders, how much was that directly related to new programs in the EV market versus other markets?

Jonathan DeGaynor, President and CEO

Well, the majority of our launches are all in on EV programs or on power programs, as we've talked about. So all of the awards are in those areas, as we said.

John Franzreb, Analyst

Fair enough. And one last question, and I'll get back into queue. In regards to the improvement in the data center market, can you kind of quantify what kind of impact that is year-over-year or any other way that kind of puts it all in context?

Jonathan DeGaynor, President and CEO

So data centers are roughly 3% to 5% of our total sales. And what we're seeing is that we're about 50% year-over-year improvement. It's above-average margin for us, and we're really excited about the opportunities that we see in that space going forward and trying to expand that business beyond the 3% to 5%.

John Franzreb, Analyst

Okay. Fair enough. I’ll get back into queue. Thanks for taking the questions.

Jonathan DeGaynor, President and CEO

Thanks for your questions, John.

Operator, Operator

Thank you. Our next question is coming from Luke Junk with Baird. Your line is live.

Luke Junk, Analyst

Great. Thank you for taking the questions, and good morning. I wanted to circle back just to the pretax income walk into the third quarter. I appreciate, Laura, the things that you shared. I'm just wondering if there's anything else that we should be accounting for in terms of things that may have been temporary in the current quarter beyond the inventory reserve. Any impacts that we should think about from the extra week that have an outsized bottom line impact either, Jon?

Jonathan DeGaynor, President and CEO

Hey, Luke, it's Jon. I'll start with the first part, and Laura can add if she'd like. Aside from the extra week, there weren't any special positive performances in Q2. As we look ahead to Q3 and discuss our perspectives on it, we recognize that it is typically our lowest revenue quarter. We are confident about the ongoing performance of the business and the progress we’re making, but we want to be open with our investors that Q3 presents challenges due to the holiday periods around the world, rather than any unique circumstances within Methode.

Luke Junk, Analyst

Okay. Then switching gears here. Wondering if you'd be able to comment just where we stand from a launch standpoint right now? In other words, you're anticipating 30-plus launches this year. Just how many of those are already in motion versus what remains to execute? And maybe if you could just remind us of the weighting to Europe and risk of any launches slipping to the right geographically specifically?

Jonathan DeGaynor, President and CEO

From a launch perspective, many of them are currently in the final development or ramp-up phase. These launches are primarily taking place in North America and EMEA, with a fairly equal distribution between the two. We have noticed that certain customers, especially those involved in EV programs, may delay the commencement of their initiatives. While there are no program cancellations, the timing of the ramp-ups is what is affected. We are collaborating with our customers to ensure transparency regarding the start dates and to manage our inventory pipeline, as well as addressing cash usage and supporting our customers effectively.

Luke Junk, Analyst

I don't know if you're able to make any specific comments relative to Stellantis, but obviously, a really important launch customer this year. Any color there would be great as well, if possible.

Jonathan DeGaynor, President and CEO

Stellantis is a very important customer for us. As we ramp up our programs, they will become one of our largest customers, generating over $200 million in revenue for us. We do notice some timing shifts, which they have made public, indicating that they are taking their time with their EV launches. This isn't new information. However, we see that EV programs represent only 20% of our total operations, so we are not overly exposed to either EV programs or Stellantis. We are comfortable with our balance among different original equipment manufacturers. Stellantis remains a key customer, and we maintain close communication with them, feeling positive about the direction of that business while keeping a close watch on it.

Luke Junk, Analyst

Got it. And then lastly, just on data center, a couple of maybe clarifying items. One, can you just help us understand within the 3% to 5% overall exposure, Industrial segment versus Interface? And then in terms of the really strong year-over-year growth, are you seeing any AI-related impacts in that business? Or would you say this is more core data center that's driving the improvement? Thank you.

Jonathan DeGaynor, President and CEO

So as we said, it is a relatively small portion of the total. It is a fairly significant year-over-year growth, and we do see both AI and just overall data center growth. And what we're exploring right now, and we're going to spend quite a bit of time on, is what are additional opportunities where we can use our capabilities more fully to actually expand this space.

Luke Junk, Analyst

Got it. I’ll go ahead and leave it there. Thank you.

Operator, Operator

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

Gary Prestopino, Analyst

Thank you. Good morning all and welcome, Laura.

Jonathan DeGaynor, President and CEO

Good morning, Gary.

Gary Prestopino, Analyst

A couple of questions, initially a little nitpicky. Interest expense looked like it was up sequentially, almost $1.4 million. Was there any one-time expenses in that interest expense number? Or is that going to be the run rate at $6.2 million per quarter for the remainder of the year?

Laura Kowalchik, Chief Financial Officer

Gary, that should be the run rate. But as debt does decrease, obviously, it will go down some.

Gary Prestopino, Analyst

Okay. Could you quantify the inventory reserve reversal in Interface that you mentioned?

Laura Kowalchik, Chief Financial Officer

Yes. The inventory reserve reduction in the Interface segment was approximately $0.5 million.

Gary Prestopino, Analyst

Okay. So $500,000. Great. Thank you. So you mentioned one of the positive aspects of the quarter was premium freight costs are down substantially, which is great news. Have you reached a point here where you feel that your premium freight costs are now more normalized? Or is there still room to improve that metric? And if you could, could you maybe share how much premium freight was down?

Jonathan DeGaynor, President and CEO

So the answer, Gary, is no, we are not in a normalized period yet. We are still making progress in reducing both premium freight and scrap costs. During the quarter, we recorded a reduction of $7 million in premium freight compared to the previous quarter. The teams, especially in Mexico, have done an excellent job stabilizing their operations compared to fiscal 2024. I expect to see ongoing improvements in both EMEA and North America in our execution. We are also conducting detailed workshops aimed at driving down scrap and continuing to reduce premium freight in both Egypt and Mexico.

Gary Prestopino, Analyst

Okay. That's all good news. I just want to talk about some of these program launches, particularly with Stellantis. But first of all, beyond Stellantis, could you maybe talk about where some of this new business is coming from? What OEMs?

Jonathan DeGaynor, President and CEO

So, until a program is in production, we're unable to disclose customer names. The new business is coming from a balance of European, North American, and Japanese OEMs. This is the extent of the information I can provide at this time regarding programs that haven't commenced production yet. The launches are mainly occurring in the European and North American markets, associated with the different nameplates and regional companies I mentioned. However, the teams worldwide are focused on ensuring that these launches are successful.

Gary Prestopino, Analyst

Let me ask you a question, Jon. I follow other companies involved in the EV market, and they create projections based on what the OEMs tell them regarding their anticipated production levels. However, we are beginning to see a decline in the EV market, which leads to adjustments in those projections as the year progresses. Could you explain how you determine your potential sales? Are you relying on the raw numbers from the OEM about their expected production levels? Please provide some insight into this because it seems that while many EVs are being introduced to the market, they are not being purchased as rapidly as before.

Jonathan DeGaynor, President and CEO

Yes. So as we've said in the past, let me talk about how we think about this first. It's easy to get focused because the press is so focused on just North American EV penetration while recognizing that we are selling into customers in the U.S., in Europe and in China. So when you think about electric vehicle market penetration in the U.S., it's about 9%. In Europe, it's 21%, 22%. And in China, it's 27%. So those take rates and the market penetration change depending on the region. So as we talk about launches both in Europe and in North America, we're not solely exposed to the North American market. That's part number one. Secondly, we don't just take the customer volumes as they give them to us. Certainly, we use that as a consideration, but we look at the sources of expert data, whether it's Global Insights or IHS or others to try to sense check what is the OE telling us, what do we read in the press as well as what global experts are saying. We sensitize then the ramp-up, the timing, the overall volumes, and therefore, what conversations we need to have with customers and what we have to do with regard to our inventory plans as well as to our CapEx plans. So that's how the approach that we're taking, Gary, is we validate or we sensitize the customer data with third-party data as well as our own subject matter expertise and try to then work with customers to make sure that we're covering our inventories and that we're scaling the capital appropriately.

Gary Prestopino, Analyst

Okay. That’s very helpful. Thank you.

Operator, Operator

Thank you. We have a question from John Franzreb with Sidoti & Company. Your line is live.

John Franzreb, Analyst

Yes. I'm just curious, is there any changes in your commercial vehicle assumptions in the coming year versus three months ago?

Jonathan DeGaynor, President and CEO

Thank you for the question, John. As we mentioned regarding electric vehicles, we depend on external forecasts like those from ACT for commercial vehicles. We anticipate a decline in 2024 compared to last year, and 2025 is also projected to be down. However, we expect some positive trends towards the end of 2025, which coincides with the middle of our fiscal year. Our situation hasn’t changed significantly over the last quarter, but we are focused on strengthening our relationships with customers. I am planning a trip to the West Coast to meet with a couple of customers before the holidays. It’s crucial for us to ensure that our relationships in the commercial vehicle sector are strong. Recently, we had customers visit our facilities in Europe, and I was there during that time. We will also meet with customers in a few weeks in the commercial vehicle segment. The commercial vehicle business is cyclical and has a different cycle than the passenger car market, with more pronounced fluctuations. Nonetheless, our commercial vehicle customers are very important to us, and we look forward to continued growth with them.

John Franzreb, Analyst

Okay. And you touched on Mexico a few seconds ago. Where are we in that process of fixing operations in Monterrey? Is that behind us? So how much more is there to go? Can you kind of talk through what's going on there?

Jonathan DeGaynor, President and CEO

There is a distinction between fixing and improving operations. Fixing suggests dealing with an uncontrolled set of issues, while improving refers to a more structured approach. I have visited our team in Mexico twice during my time here, and I previously mentioned achieving a $7 million reduction in premium freight quarter-over-quarter, mostly attributed to efforts in Mexico. The team has successfully transitioned from fixing problems to focusing on improvements. Though there is still much work ahead, the leadership there, along with support from our global organization, is making significant progress. This is now more about exploring controlled opportunities rather than just addressing a series of uncontrolled problems. Does that make sense to you, John?

John Franzreb, Analyst

Yes, it's a start. I get it. Fair enough. And one other question. Your reduction in the CapEx spending, does that represent just lower required spending or a change in the timing of that spending from this year to next year?

Jonathan DeGaynor, President and CEO

Some of both, as we consider customer needs and evaluate EV programs. My background is in operations, and we assess the initial capital assumptions along with the opportunities for capital efficiency. We've achieved significant productivity in areas like SMT, where we avoided some previously planned investments. This results in both a reduction in capital spending and timing adjustments based on the direction of customer programs.

John Franzreb, Analyst

All right. And I guess one last question to bother everybody here. The cash outflow was kind of sizable in the quarter. Will we be able to recapture that with cash inflows by the end of the fiscal year? Or will it be a net cash outflow year?

Laura Kowalchik, Chief Financial Officer

Yes. We are certainly looking to reverse some of that cash outflow in the next two quarters, and we certainly expect to be approaching neutral.

John Franzreb, Analyst

Fair enough. Perfect. Thank you very much.

Operator, Operator

Thank you. As we have no further questions on the lines at this time, I would like to hand the call back over to Mr. DeGaynor for any closing comments.

Jonathan DeGaynor, President and CEO

Yes. Thank you, operator, and thank you to everybody who joined us on the call today. Thanks for your interest and for your questions. We look forward to updating you on our Q3 call. Once again, we appreciate all your interest in the company.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes today's call, and you may disconnect your lines at this time, and we thank you for your participation.