Methode Electronics, Inc. (NYSE:MEI) Q1 2024 Earnings Call Transcript

Methode Electronics, Inc. (NYSE:MEI) Q1 2024 Earnings Call Transcript September 7, 2023

Methode Electronics, Inc. misses on earnings expectations. Reported EPS is $0.02 EPS, expectations were $0.22.

Operator: Greetings and welcome to the Methode Electronics First Quarter Fiscal 2024 Results Call. At this time, all participants are on a listen-only mode, and a question-and-answer session will follow the formal presentation. [Operator Instructions] 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.

Robert Cherry: 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.

Don Duda: 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 unmethylated, like, operational challenges. Operational inefficiencies in our North American auto operations are caused mainly by salary personnel turnover, poor operational decisions, and vendor issues, which led to subsequent production planning deficiencies. There’s some turn at a domino effect leading to inventory shortages, unreimbursed spot purchases, and 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 operating inefficiencies that our early warning system detected but we failed to mitigate also very on Methode. In a lean manufacturing environment, a delay and 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 an addition to quality is absolutely paramount to both maintaining and obtaining new business.

These operational challenges had approximately $0.15 impact on our first quarter earnings relative to our expectations. We also had accelerated expenses related to the 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 former seasoned planners in the U.S. However, the residual effects are expected to impact our second quarter to approximately the same degree, and along with a significant weakening of the e-bike market, the primary drivers to our lowering earnings guidance for the full-year. As I’ve said, this was very unmethylated 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 the 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 a 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, activity will be strong, but we’ll 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, which is driven by an investment in working capital 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 identified here represent some of the key wins in the quarter and represent $70 million in annual sales at full production. As a reminder, the launch timing of most of these programs could be anywhere in the range of one to three years from now. The awards are mainly for power products associated with the EV skateboard architecture, the awards also continue to be weighted towards the United States where EV quoting activity continues to be strong. In other areas, we are awarded programs for lighting solutions in auto and sensor solutions and e-bikes although not launching until fiscal 2026. Turning to slide six. In summary, sales in the quarter continued to be solid including 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 laps 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 have a heavy focus on executing our new program launches. Turning to our outlook. Due to program roll-offs and the expected weakness in key markets especially e-bikes, we continue to expect low organic sales in fiscal 2024. In addition, we will be making significant investments and launching over 20 new programs. These investments include significant tooling and increased staffing to ensure a successful 2025.

This activity along with multiple years of strong awards is expected to enable us to not only replace the sunsetting programs but to organically grow the business 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 into 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 our team 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 we’ll 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. Ron?

Ron Tsoumas: 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 in a year-over-year cost recovery impacts sales decreased by 1.5%. In addition to Nordic Lights, this quarter’s ongoing strength lighting solutions for commercial vehicles, but it 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 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 from the operational inefficiencies, 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, a 53.4% decrease. EBITDA was negatively impacted by the higher operational costs, 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 wasn’t an outflow of $5.6 million as compared to an inflow as compared to $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. The 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 again was primarily due to reduce net income and increase 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 expected adjusted diluted earnings per share is $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 of $0.80 to $1 down from a previous range of $1.55 to $1.75. The drop is predominantly related to the operational inefficiencies in North America and auto being experienced in the first and second quarters and 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 $0.12 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.

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

See also 13 Mistakes to Avoid When Divorcing Over 50 and 12 Undervalued Dividend Aristocrats To Buy.

Q&A Session

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

Luke Junk: 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 more specifically 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 the action doesn’t have the expected benefit? Thank you.

Don Duda: Okay. 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 where there are the 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. And that’s really — when I look at the miss, that’s the main driver of it. Confidence, we know this will go into the second quarter. We’ve dropped the inventory levels, we need to replenish some of that. So, we’re going to still have some premium freight more inbound and outbound this time. What’s my confidence level? Hi, 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 on Methode, it’s disturbing to me, but we’re pretty seasoned management team, the plant, let’s call it a transition to going from high-volume to low mix, center consoles which they did very well producing. To a high mix, lower volume, and had some issues with that coupled with employee turnover some voluntary and some involuntary. And so, some decision-making that we’re correcting. I am confident of that. We’re known for our operational excellence. So, this one is — we will replace for me. But we will correct that I’m confident. We’ve had some corporate people down there that are seasoned ops guys and we know what the fix is.

Luke Junk: 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?

Don Duda: That’s always a double-edged sword for us. We’ve had some — very difficult stressful discussions with our customers. And some of this is not with us but some of this has been in the past where the automakers have been getting even tougher on price concessions. So, that is going to be a struggle going forward. Now where we’ve turned our attention to is our PPV or Purchase Price Variance which for the last couple of years has been negative. We feel that with our growth, we can put pressure on our suppliers or get other suppliers although I will tell you one of the issues we had in our Monterrey plant was we did change the supplier and had an issue, also that has to be done carefully. We’ll continue to pressure customers for price increases, but I’m not going to destroy the relationship.

We’re — auto and while we’ve diversified, there’s only so many automakers and so we tread lightly there, although again I think our team has done a good job of pushing it. But I think our attention in terms of gross margin will be in factory efficiencies and improving that and with putting more pressure on our vendors. I see that as a better avenue than taking a customer in relation to the bank and being put our new product coal, I don’t think that long term, I don’t think that will help Methode. And we will get as we launch these programs, particularly in Monterrey, we’re going to get more overhead coverage that will also help us going forward. Ronald will give you the…