Earnings Call Transcript
Methode Electronics Inc (MEI)
Earnings Call Transcript - MEI Q4 2020
Operator, Operator
Good day, ladies and gentlemen. Welcome to the Methode Electronics Fourth Quarter Fiscal 2020 Results Call. After the presentation, there will be a question-and-answer session. At this time, it’s my pleasure to turn the floor over to Mr. Rob Cherry, Vice President of Investor Relations. The floor is yours.
Rob Cherry, Vice President of Investor Relations
Thank you, Operator. Good morning. And welcome to Methode Electronics fiscal year 2020 fourth quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2020 Fourth Quarter and Full Year Financial Results, which can be viewed on the webcast of this call or found at methode.com in the Investors section. 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 call involve a number of risks and uncertainties. The factors that could cause actual results to differ materially from expectations are detailed in Methode’s filings with the Securities and Exchange Commission, such as our annual and quarterly reports. Such factors may include, without limitation, the following; impact from pandemics, such as the COVID-19 pandemic; dependence on the automotive, appliance, commercial vehicle, computer and communications industries; dependence on a small number of large customers, including two large automotive customers; international trade disputes resulting in tariffs and our ability to mitigate tariffs; timing, quality and cost of new program launches; ability to withstand price pressures, including pricing reductions; failure to attract and retain qualified personnel; ability to successfully market and sell Dabir Surfaces products; currency fluctuations; customary risks related to conducting global operations; costs associated with environmental health and safety regulations; ability to withstand business interruptions; recognition of goodwill and long-lived asset impairment charges; ability to successfully benefit from acquisitions and divestitures; investment in programs prior to the recognition of revenue; dependence on the availability and price of materials; dependence on our supply chain; judgments related to accounting for tax positions; income tax rate fluctuations; ability to keep pace with rapid technological changes; impacts to our information technology systems; ability to avoid design or manufacturing defects; costs associated with reorganization activities; ability to compete effectively; ability to protect our intellectual property; success of Grakon and/or our ability to implement and profit from new applications of the acquired technology; significant adjustments to expense related to our performance-based stock awards in our long-term incentive plan; ability to manage our debt levels and any restrictions thereunder; and impact to interest expense from the replacement or modification of LIBOR. At this time, I’d like to turn the call over to Mr. Don Duda, President and Chief Executive Officer.
Don Duda, President and Chief Executive Officer
Thank you, Rob, and welcome to Methode. Good morning, everyone. And thank you for joining us today for our fiscal 2020 fourth quarter and full year financial results conference call. I am joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I have opening comments and afterwards we will take your questions. First, I would like to note that our fiscal 2020 accounting period included 53 weeks versus 52 weeks for fiscal 2019. Also, the fiscal 2020 results include 12 months of Grakon activity, as compared to seven and a half months of Grakon activity in the fiscal 2019 results. As you can see on slide four, I would also like to draw your attention to our refreshed Corporate and Investor Relations websites. We believe both provide improved user experience, as well as better depth and visibility of information. Please turn to slide five. Methode’s full year revenue increased 2.4%, our net income increased 34.7% and our diluted earnings per share increased 34.2% for the fiscal year ended May 2nd of 2020. All three financial measures were a record for Methode. The cost reduction and operational efficiency initiatives that we implemented in fiscal 2019 provided the savings we expected in fiscal 2020. On a non-GAAP basis, our adjusted net income increased 5.7% and adjusted diluted earnings per share was up 5.4%. These adjusted measures exclude expenses for initiatives to reduce overall costs and improve operational profitability, acquisition-related costs, long-term incentive plan accrual adjustments and the transition tax benefits from U.S. Tax Reform in the applicable periods. As you can see, on both the GAAP and adjusted basis, it was a commendable performance for the year that drove record free cash flow increasing over 48% over fiscal 2019. On slide six is our full year revenue bridge, which includes the benefit of an extra four and a half months of Grakon activity and $76 million in sales from new program launches. Speaking of Grakon, I am happy to report that we completed the integration and are pleased that the acquisition delivered the results we expected. Adversely affecting the year was a UAW labor strike that occurred in our second quarter and the impact from COVID-19 in the fourth quarter. After the negative impact from foreign currency exchange, the full year revenue performance was still up approximately $24 million to a record level. In regard to COVID-19, our focus continues to be on the health and safety of our employees who have shown incredible dedication to Methode and our customers in light of extraordinary circumstances across the globe. Given this health crisis and business disruption, we have implemented measures to manage cost, preserve liquidity, and, most importantly, address employee safety. The safety measures include enhanced cleaning and disinfection procedures at our facilities, the promotion of social distancing, a majority of office staff working from home and stringent factory and office protocols for proactive COVID-19 mitigation. Methode was able to apply the early lessons learned in its Asian operations developing actions and protocols to deal with COVID-19 and leverage them in our plants and facilities in the rest of the world as the pandemic spread. As a result of these mitigations and given the essential nature of some of our businesses, all of our facilities remained open to a certain degree and operated at levels commensurate with customer orders. In fiscal 2021, we will continue to see significant headwinds, especially in the first quarter from the COVID-19 pandemic. However, I want to stress that we will continue to invest in our businesses for the long-term. Moving to slide seven. During the fourth quarter new awards in the Automotive and Industrial segments continued to capitalize on important trends, including vehicle electrification and the incorporation of LED lighting and sensors to augment safety. We are very pleased that we booked over $36 million in new annual business in the fourth quarter with our total fiscal 2020 exceeding $141 million. In the quarter, Methode was awarded several key programs tied to our ongoing strategy. In electric vehicles, we were awarded programs for Busbar and AC Power Connectors totaling $10 million annually. In sensors, we were awarded a program in China for e-bikes for $2.3 million annually. In vehicle exteriors, we were awarded an initial Integrated Tailgate Module program for a Japanese auto OEM for $1.7 million. As we have successfully accomplished in the past, Methode will continue to evolve its business with new technology and products such as our unique sensors, LED lighting and power solutions for electric vehicles. And we will develop innovative products for new applications like remote controls for industrial drones, which is an up and coming market for our Hetronic business. In the Medical segment, our efforts to grow the Dabir product line in the quarter were hampered by the postponement of elective surgeries due to COVID-19. When the pandemic subsides and hospitals return to normal, we believe that business will return to a growth trajectory. Looking forward, we are not providing annual guidance for fiscal 2021 due to the ongoing market uncertainty and the resulting lack of customer demand visibility due to the COVID-19 pandemic, which includes our fiscal first quarter. Most auto and commercial vehicle production was shut down before the beginning of our fiscal 2021 first quarter until approximately mid-June or roughly the first half of the quarter. When production did resume, the demand was irregular and we continue to see volatility in forecasts as of today. As such, any quarterly guidance we were to give would be heavily weighted to July and would carry a range of uncertainty that would not provide meaningful insight. While we are not providing any guidance at this time, we do intend to provide partial year guidance at a future date as soon as the demand schedule stabilizes and we are confident with our customers’ forecasts. As part of our continuous improvement strategy and an effort to manage cost and cash, Methode is taking further actions to consolidate operations and further streamline our organization in order to improve efficiencies and set the stage for continued growth. These actions will allow us to further improve on our S&A as a percent of sales and be in a better position to capitalize on opportunities as they present themselves. To conclude, given the current global macroeconomic situation and the significant headwinds faced by Methode throughout this past fiscal year, I am extremely pleased that our strategy and team were able to deliver record revenue and income and generate a record free cash flow. That said, our focus now is to continue navigating COVID-19, while executing our long-term plans as we enter a new fiscal year. At this point, I will turn the call over to Ron, who will provide more detail on our financial results. Ron?
Ron Tsoumas, Chief Financial Officer
Thank you, Don, and good morning, everyone. Please turn to slide eight. Fourth quarter sales decreased 20.8% or $55.4 million to $210.6 million in fiscal ‘20 from $266 million in fiscal ‘19. Sales in the fourth quarter were negatively impacted by COVID-19, especially in the mid-to-late March and April timeframes. These production shutdowns, most of which impacted the Automotive and Industrial segments, continued through the end of the fiscal fourth quarter and had a negative impact of approximately $85 million on net sales. Foreign currency exchange continued to be a headwind as both the euro and renminbi exchange rates were weaker than the prior year reducing net sales in the quarter by $3.5 million. On a GAAP basis, fourth quarter net income increased $7.5 million to $3.1 million or $0.79 per share from $22.6 million or $0.60 per share in the same period last year. Fourth quarter GAAP net income benefited from the adjustment of long-term incentive accruals of $6.5 million and higher other income of $5.5 million, primarily due to higher international government grants inclusive of COVID-19 assistance. In addition, we realized a benefit from initiatives to reduce costs and improve profitability taken in fiscal 2019, which included lower expenses for those actions in the current fiscal year versus last fiscal year. Adjusted net income, a non-GAAP financial measure, was $25.4 million or $0.67 per diluted share, as compared to $23.5 million or $0.62 per diluted share in the same quarter of fiscal 2019. Adjusted net income excluded expenses for initiatives to reduce overall costs and improve operational profitability, acquisition-related costs, and long-term incentive plan accrual adjustments in the applicable periods. Moving to gross margins on slide nine. Fourth quarter GAAP gross margins were higher in fiscal ‘20 as compared to fiscal ‘19 and benefitted from the sales mix within the Automotive and Industrial segments, including increased sensor sales and increased sales in the Interface segment, but were negatively impacted by sales volume reductions due to the impact of COVID-19 and foreign currency translation. Non-GAAP adjusted gross margins, a financial measure, which excludes expenses or initiatives to reduce costs and improve profitability and purchase accounting adjustments in the applicable period, were higher in fiscal ‘20, as compared to fiscal ‘19. Fourth quarter GAAP selling and administrative expenses as a percentage of sales decreased 370 basis points year-over-year to 8.6%, compared to 12.3% in the fiscal ‘19 fourth quarter. The fourth quarter attributable figure was due to long-term incentive plan accrual adjustments, lower performance-based cash compensation expenses and lower salary resulted from the COVID-19 cost-saving actions. Our adjusted selling and administrative expenses as a percentage of sales, a non-GAAP financial measure, decreased slightly to 11.6% from 12% in the fiscal 2019 fourth quarter. This included exclusion of acquisition-related costs, expenses for initiatives to reduce overall costs and improve profitability, and long-term incentive plan accrual adjustments in the applicable period. Moving to year-to-date margins on slide 10. Year-to-date GAAP gross margins improved 100 basis points, but non-GAAP adjusted gross margins improved by only 20 basis points in the year-over-year comparisons. Gross margins were affected by the impact of COVID-19 and the UAW labor strike at GM, the negative impact of foreign currency translation and lower radio remote control sales. These items were partially offset by the benefit of a full year of Grakon sales and increased sensor sales. Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce costs and improve profitability and purchase accounting adjustments in the applicable period. Year-to-date GAAP selling and administrative expenses as a percentage of sales decreased 290 basis points year-over-year, positively impacted by lower stock-based compensation expense, the fiscal ‘20 benefit from fiscal ‘19 actions aimed at reducing costs, lower acquisition costs and selling and administrative expense attributed to Grakon, which is lower as a percentage of sales than Methode as a whole. Non-GAAP selling and administrative expenses as a percentage of sales, which exclude acquisition-related costs, operational improvements, and long-term incentive plan accrual adjustments decreased by 50 basis points on a year-to-date basis. Shifting to EBITDA on slide 11. The company generated $54.5 million in the fiscal ‘20 fourth quarter versus $46.1 million in the same period last year. The EBITDA figure was accomplished in spite of the significant headwinds from the COVID-19 pandemic, which reduced sales by $85 million. Adjusting for expenses for initiatives to reduce overall costs and improve operational profitability, acquisition-related costs, and long-term incentive plan accrual adjustments in the applicable period, fourth quarter fiscal ‘19 adjusted EBITDA was $47.2 million, as compared to $48.3 million in the current period. Moving to the year-to-date EBITDA on slide 12. The company generated $207.1 million in fiscal ‘20 versus $155.2 million in the same period last year in spite of the impact from COVID-19 and the UAW strike at GM. Adjusting for expenses for initiatives to reduce overall cost and improve operational profitability, acquisition-related costs, and long-term incentive plan accrual adjustments in the applicable period, fiscal ‘19 adjusted EBITDA was $184.9 million, as compared to fiscal ‘20’s $203.7 million. The improvement was primarily attributable to higher EBITDA from Grakon's 12 months of activity versus seven and a half months and new product launches, partially offset by the adverse impact from COVID-19 and the UAW strike at GM. Now a few other financial items to review. Year-over-year, intangible asset amortization expense in fiscal ‘20 increased $2.9 million or 18% to $19 million due to amortization expense related to the Grakon acquisition, partially offset by lower amortization in the Interface segment. In fiscal ‘20, we invested approximately $45 million in capital expenditures, mainly to support programs and launches in North America and Europe, and our facility expansion in India. Year-to-date depreciation expense for fiscal ‘20 was $23 million. Our year-to-date tax rate of 17% was higher than the 11.6% in fiscal ‘19. This is mainly due to increased income and higher tax rate jurisdictions, an increase of tax reserves, less investment tax credits and lower benefits realized from the finalization of the transition tax from U.S. Tax Reform. Let’s move to slide 13. Free cash flow as defined as net income plus depreciation and amortization less CapEx for fiscal ‘20 was $126.6 million, as compared to $85.1 million in fiscal ‘19. The cash flow figure represents a record for Methode. As shown on slide 14, we have used some of our cash generation to pay down debt. We have reduced net debt by nearly $75 million since the beginning of the fiscal year and since the acquisition of Grakon, we have reduced our net debt by nearly $112 million. We ended the fourth quarter with $217.3 million in cash, which includes the $100 million precautionary draw in the credit facility we initiated in March. Our debt-to-EBITDA ratio, which is used for our bank covenants, is approximately 1.7. This figure includes the impact of the proactive $100 million draw we initiated. Without the draw, the ratio would have been 1.2. Please move to slide 15 to look at our key drivers of our EBITDA performance for fiscal ‘20. Looking at the EBITDA based on our $155 million of EBITDA in fiscal ‘19 and adding EBITDA from a full year of Grakon, which is approximately $24 million, adding EBITDA from our new automotive and laundry program launches of approximately $18 million, benefits from the costs we incurred in fiscal ‘19 for initiatives to reduce costs and improve profitability of around $11 million, adding back the costs we incurred in fiscal ‘19 related to acquisitions and initiatives to reduce costs and improve profitability of around $29 million and increasing our anticipated international government grant income, which includes COVID-19 assistance of $6 million, and subtracting the net impact of COVID-19, the UAW labor strike and other collective net impacts to the business for a total of minus $36 million. Don, that concludes my comments.
Don Duda, President and Chief Executive Officer
Ron, thank you very much. Tom, we are ready to take questions.
Operator, Operator
Thank you, sir. We will take our first question from Ryan Sigdahl with Craig-Hallum.
Ryan Sigdahl, Analyst
Great. Thanks, guys for taking my questions.
Don Duda, President and Chief Executive Officer
Good morning, Ryan.
Ryan Sigdahl, Analyst
First just want to start, this past year as well as challenging as it can get, it seems with the UAW strike late last year, COVID shutdowns more recently. I know you are not giving specific guidance and understandably so, but directionally, is it reasonable to assume that key financial metrics can improve year-over-year?
Don Duda, President and Chief Executive Officer
Did you say, cannot improve?
Ryan Sigdahl, Analyst
Well, can or can’t, I said, can. It seems like some of those headwinds will pass here and should be a better year this year. But just curious directionally any commentary you can make on kind of key financial metrics, revenue margins, free cash flow, et cetera?
Don Duda, President and Chief Executive Officer
I believe that due to the first quarter being somewhat unpredictable and possibly being shut down for about half of the quarter, we are likely not going to have as strong a year as we did last year. However, once we return to more normalized production, which is uncertain in timing, we will start to see the advantages of the actions we took in fiscal ‘20. At this moment, it’s challenging to forecast whether we will see an improvement compared to last year, especially without knowing what the next few months will bring. On an annualized or run rate basis, there may be improvements, but I cannot confirm that at this time.
Ryan Sigdahl, Analyst
As we consider the current quarter, which is Q1, could you provide any insights on the impact of COVID-19 and its influence on production schedules for Q1 compared to Q4?
Don Duda, President and Chief Executive Officer
Well, COVID hit at the end of it, really six weeks into the fourth quarter.
Ron Tsoumas, Chief Financial Officer
Mid-March.
Don Duda, President and Chief Executive Officer
Yeah. Mid-March.
Ron Tsoumas, Chief Financial Officer
Starting...
Don Duda, President and Chief Executive Officer
The impact began with a simultaneous shutdown of customers globally and continued until just a few weeks ago. As I mentioned earlier, none of our facilities closed; we were still shipping some products, particularly those deemed essential. However, we experienced a decrease of $85 million in the quarter. Currently, the schedules remain inconsistent, not just in the U.S., as customers worldwide are releasing products, then pausing, and subsequently releasing others as they attempt to adjust to consumer demand. When I look ahead, it's essential for the automakers and our other customers to replenish their inventories, yet we need to understand consumer demand, which remains uncertain. There have been some strong sales, notably in the U.S. during April, though less so in Europe. Looking to the future, the situation is still unpredictable. Do we expect to see stabilization eventually? Yes, but the recent rise in COVID cases in the U.S. raises concerns, and we truly do not know what the fall will bring. Ron?
Ron Tsoumas, Chief Financial Officer
No, I believe that given the current revenue declines we are facing, depending on how this affects the next fiscal year, it will be difficult to maintain margins due to the negative impact from lower sales. The extent of this challenge will largely depend on how quickly everything stabilizes during the recovery.
Don Duda, President and Chief Executive Officer
No. What we are doing is, as we said, we are taking actions to streamline our organization much like we have done in years past and one of our base strategies is continuous improvement. So we are taking actions to reduce our cost basis in our S&A, which will benefit us as things start to normalize, but the question is, when do they normalize.
Ryan Sigdahl, Analyst
Yeah. No. That’s a fair and I appreciate the color. Switching over to Interface, can you break down the benefit from the major appliance program launch, which was good to see versus the higher legacy data solution product? And then, secondly, is $19 million-ish revenue that you had in the quarter, is that a good run rate kind of thinking about the new appliance program launch you had?
Don Duda, President and Chief Executive Officer
The $19 million, correct me if I am wrong Ron, it also included our auto launches, correct?
Ron Tsoumas, Chief Financial Officer
It did. Yeah. So we are sitting here at about $60 million for the year last year. So, yeah, I think that would be with the new launches and everything in full launch. The data solutions were up a little bit. They were considered essential business and we were able to continue shipping. So we got a nice little uplift that during the quarter, but it’s hard to say what the rest of the year will look like into this fiscal year.
Don Duda, President and Chief Executive Officer
But just to add to that, we would expect the launch of the laundry program for our key customer to continue.
Ryan Sigdahl, Analyst
Right.
Don Duda, President and Chief Executive Officer
Now again that could be affected by consumer confidence, but we would expect that they would have a better year than what they have had because the launch was so delayed.
Ryan Sigdahl, Analyst
Good. One last one for me and then I will turn it over. Curious what you can say or what potential, or maybe you have content in words already, but some of the newcomers in EVs, so Nikola, Rivian, et cetera, anything you can comment on those?
Don Duda, President and Chief Executive Officer
I can't comment exactly on what the programs are. We have Rivian programs, which is a key focus for us. I am also looking into what we are doing with the other projects. We are indeed working with both of those. Although I can't disclose the extent of our involvement, we received feedback from another customer regarding this. However, we are collaborating with them, and our product aligns very well with their needs.
Ryan Sigdahl, Analyst
Good. That’s it for me. Thanks guys. Good luck.
Don Duda, President and Chief Executive Officer
Thanks, Ryan.
Ron Tsoumas, Chief Financial Officer
Thanks.
Operator, Operator
We will go next to Matt Sheerin with Stifel.
Matt Sheerin, Analyst
Yeah. Hi. It’s Matt Sheerin from Stifel. Thanks for taking my question. Your commentary regarding the sort of erratic order environment from customers and not a surprise, but could you give us some view in terms of whether you think there’s some inventory work down that’s happening or is it more just a question of your customers trying to understand what their end demand is and that’s why you are adjusting the order schedules?
Don Duda, President and Chief Executive Officer
In response to that question, I would say that what we've observed in the initial restart is inventory replenishment. It seems like this is normalizing, but our perspective on managing unpredictable demand remains straightforward. Dealer traffic has been strong, which gives us confidence that consumer sentiment is still robust enough to support auto sales.
Matt Sheerin, Analyst
Thank you for that. I know that IHS is predicting significant production growth in the third quarter, particularly as factories resume operations. However, how do you relate this to actual production in terms of when you expect to see an increase in orders?
Don Duda, President and Chief Executive Officer
That's a great question. We benefit from customer releases, and usually, in the auto industry, weekly and monthly releases are quite dependable. However, as we look out three to six months, we do see some softness. Recently, there has been significant volatility even in weekly schedules, which is a concern for us. I agree that IHS is projecting Q3 growth, and we consider that alongside LMC and our own releases. At the moment, I don’t see a direct correlation. Eventually, whether it's Q3 or another time, it's crucial that we can react to any increase in demand. We're prepared for that. We've assessed all our supply lines, vendors, and inventory. Once demand rises—and it will—if customers want the product, we can certainly ship it without delays. Since the crisis began, we have not experienced any delays for customers, although we've had some vendor challenges across the board. If demand is there, we are ready to supply and benefit from it.
Matt Sheerin, Analyst
Okay. And your lead times are at normal levels right now, could you remind us what they are?
Ron Tsoumas, Chief Financial Officer
Yeah.
Don Duda, President and Chief Executive Officer
Yeah. The lead times.
Ron Tsoumas, Chief Financial Officer
For the customer.
Don Duda, President and Chief Executive Officer
I mean it’s just in time…
Ron Tsoumas, Chief Financial Officer
Supply demand.
Matt Sheerin, Analyst
Okay. So you have inventory in the hubs. Okay. All right. Okay. Thanks. Thanks so much for the color. I appreciate it.
Don Duda, President and Chief Executive Officer
Okay.
Operator, Operator
And there appear to be no further questions in the queue. At this time, I’d like to turn the call back over to Mr. Duda for any closing remarks.
Don Duda, President and Chief Executive Officer
Tom, thank you very much. We will close with wishing everyone a very safe and enjoyable independence holiday. Thank you for listening today.
Operator, Operator
And ladies and gentlemen, this does conclude today’s conference. We appreciate your participation. You may disconnect at this time and have a great day.