Methode Electronics Inc (MEI) 2023 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Methode Electronics First Quarter fiscal 2023 Results Call.

(Operator Instructions)

It is now my pleasure to turn the floor over to your host, Robert Cherry, Vice President of Investor Relations. Sir, the floor is yours.

Thank you, operator. Good morning, and welcome to Methode Electronics Fiscal 2023 First Quarter Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2023 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 statements 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-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 2023 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'll take your questions.

Let's begin with the highlights on Slide 4. Our sales for the quarter were $282 million, helping our sales by $11 million were successful spot buy and premium freight cost recovery efforts. Working in the opposite direction was foreign currency, which had a negative $14 million impact on sales. Also working against us were market headwinds in our automotive segment in Asia and Europe.

In Asia, the COVID-19 lockdowns in China impacted the end of our fourth quarter as well as the beginning of our first quarter. In Europe, we saw continued weakness in the auto market due to macroeconomic conditions. Helping to offset the weaker auto sales was a record quarter of sales in our Industrial segment. The surge in industrial sales was driven by power distribution both for data center and EV applications and by commercial vehicle lighting. This is in keeping with our strategic direction to grow our Industrial segment.

In the quarter, we continue to face the ongoing supply chain challenges. Our team is still working diligently to mitigate their impact, which requires remedial actions such as spot buys and expedited shipping. We have worked relentlessly with our customers to share in the absorption of these increased costs. These costs include inflation in material, labor and freight. Our ability to obtain reimbursement to offset these costs will lag as a matter of process as long as inflation continues.

On the order front, we had another very strong quarter with over $90 million in program awards. As you will see later, these awards were in a variety of applications and once again, were led by EV programs. Focusing on EV, like last quarter, EV sales were 17% of consolidated sales. This percentage, which was 19% 2 quarters ago, was again directly impacted by the COVID-19 lockdowns in China. With those lockdowns seemingly behind us and given the ongoing momentum in our EV activity, we still expect EV sales to reach a record 20% of our total sales in this fiscal year.

In the quarter, we had positive free cash flow and purchased approximately $12 million of Methode stock. As of the end of the first quarter, we now have approximately $117 million of capacity in our buyback authorization, which expires in June 2024. Further, our debt is at its lowest level since the Grakon acquisition.

Moving to Slide 5. Methode had another very strong quarter of business awards. The awards identified here represent some of the key wins in the quarter and represent over $90 million in annual sales at full production. As a reminder, the full launch timing of most of these programs could be anywhere in the range of 1 to 3 years from now. Also, while most of the dollar value of these awards are for new programs, some of these awards are for extensions or volume increases on existing programs.

At the top of the list, our EV programs representing over 40% of the total dollar value. The awards are mostly for power products and are from all of the additional big 3 U.S. automakers. The EV growth engine rolls on and our exposure to it continues to be robust.

In non-EV automotive applications, we were awarded programs for all 4 of Methode's core technologies, user interface, power, sensor and lighting applications. Also notable is there in our 2 historically fastest-growing regions Europe and Asia.

We also had solid awards for applications in motor-sports, e-bikes and mil-aero. Here as well, we had good award diversity with lighting, sensor and power products. Overall, it was a very successful quarter for awards that will drive organic sales growth in future years.

To conclude, we continue to be cross challenged by inflation, which is yet to stabilize. However, our team is working every day to mitigate the impact, and we expect more progress as the year goes on.

Looking forward, I am confident that Methode is positioned to mitigate these pressures and deliver sales and earnings growth for fiscal 2023. This confidence has enabled us to confirm our sales and earnings guidance for the year.

At this point, I'll turn the call over to Ron, who will provide more detail on our first quarter financial results and outlook for the full year. Ron?

Thank you, Don, and good morning, everyone.

Please turn to Slide 7. First quarter net sales were $282.4 million in fiscal year '23 compared to $287.8 million in fiscal year '22, a decrease of $5.4 million or 1.9%. Fiscal year '23 sales included $11.1 million of spot buy and premium freight cost recovery and unfavorable currency impact on sales of $14.2 million. Excluding the spot buy and premium freight cost recovery and the foreign currency impact, sales decreased by $2.3 million or 0.8%. Sales declined in the Automotive segment, but increased in the Industrial segment.

The Automotive segment saw a sales decrease of $19.2 million or 9.8%. Net sales were negatively impacted by foreign currency exchange of $8.9 million but benefited from spot buy and freight recovery sales of $9.1 million. In North America, the $4.4 million decrease in the first quarter sales included the full impact from the roll-off of a major automotive program. In Asia, Automotive segment sales decreased $9.1 million or 23.4% primarily due to China's COVID-19 zero-tolerance lockdown and the shutdown of a large customer's facility in July. We anticipate recovering a portion of the lost sales in the first quarter in our second quarter.

In Europe, sales declined $5.7 million or 9.9%, largely due to foreign exchange headwinds of $7.7 million, partially offset by cost recoveries of $1.2 million. In addition to foreign exchange, sales were impacted by general economic uncertainty in the region. The weakness in the automotive segment was partially offset by record sales in our Industrial segment, which experienced a sales increase of $13.6 million or 17.3%, resulting from strength in our commercial vehicle lighting and industrial non-EV power-related product offerings.

EV product applications amounted to 17% of sales in the quarter. This figure was adversely impacted from the lockdown and shutdown activity in China. Currently, we expect recovery in the next several quarters and still anticipate EV and hybrid electric vehicles to represent 20% of our full year fiscal '23 consolidated sales.

First quarter income from operations in fiscal year '23 decreased to $21.8 million from $34.1 million in fiscal year '22, mainly due to lower product sales, lower gross margins, mainly due to higher costs due to material cost inflation, spot buys and other unreimbursed costs, the impact of overhead absorption due to a roll-off of a major automotive program and modestly higher selling and administrative perspective.

From a gross margin perspective, cost recovery actions did not keep pace with the accelerated inflation and other increased costs. It will take time to catch up on cost recovery, but actions are in process for recovery in future periods. These factors were partially offset by higher other income in the form of international government COVID-19 assistance, which increased from the $1.9 million in the first quarter of fiscal year '22 to $4.1 million in the first quarter of fiscal year '23.

The other income spiked in the first quarter, and we do not expect this elevated quarterly level of government assistance during the remainder 3 quarters of the fiscal year.

First quarter net income in fiscal '23 decreased $7.6 million to $21.5 million or $0.58 per diluted share from $29.1 million or $0.76 per diluted share in the same period last year. Sequentially, from the fourth quarter of fiscal year '22, diluted earnings per share increased $0.15 per share from $0.43 to $0.58 per diluted share.

Please turn to Slide 8. Fiscal year '23 first quarter gross margins were 21.9% as compared to 24.9% in the first quarter of fiscal year '22. A contributing factor and the decline in the consolidated gross margin profile was the increase in pass-through cost recovery sales at zero margin, which led to lower net product sales. When the MP of these sales is removed, fiscal year '23 first quarter consolidated gross margins would have been 22.8%.

Automotive segment gross margins decreased to -- decreased 30% in the quarter of fiscal year '23, down from the 36.3% gross margins in the first quarter of '22, mainly due to decreased sales in North America and Asia.

Industrial segment gross margins decreased to 33% in the first quarter, down from 36.3% gross margin in the first quarter of fiscal '22. Of the overall segment gross margin decrease, approximately 75% was due to material cost inflation, increased freight and logistics costs and 25% was related to inventory items sums as unfavorable absorption due to China lockdowns and increased profit in ending inventory eliminations and other items.

The 33% Industrial segment gross margins are more in line with the historical norms and barring any substantial change in commercial vehicle or EV production levels, we anticipate opportunity for modest improvement in the Industrial segment margin for the remainder of the current fiscal year.

Fiscal year '23 first quarter selling and administrative expenses as a percentage of sales was 12.5% as compared to 11.4% in the first quarter of fiscal year '22 mainly due to increased wages and other general administrative expenses and travel.

Our selling and administrative expense as a percentage of sales is reasonably consistent from a cost structure perspective and should yield an efficient flow-through from gross margin to income from operations.

Please turn to Slide 9. Net income was negatively impacted from the operational items noted above, partially offset by higher income, lower tax expense and lower net interest expense. The effective tax rate in fiscal -- first quarter of fiscal '23 was 17% as compared to 16.4% in the first quarter of fiscal year '22. The minor change in the effective tax rate was due to a mix of jurisdictional earnings.

Shifting to EBITDA, a non-GAAP financial measure, fiscal year '23 first quarter EBITDA was $38.2 million versus $48.5 million in the same period last fiscal year. EBITDA was negatively impacted by the higher cost due to material cost inflation, spot buys and premium freight, lower product sales volumes and unfavorable product mix, partially offset by other income.

Please turn to Slide 10. In the first quarter of fiscal year '23, we reduced gross debt by $3.3 million. Since our acquisition of Grakon in September of 2018, we have reduced gross debt by $150 million. Net debt, a non-GAAP financial measure, increased by $16.3 million to $54.8 million in the first quarter of fiscal year '23 from $38.5 million at the end of fiscal '22, mainly due to the share repurchases of $11.9 million and unfavorable working capital changes, especially related to inventory which increased significantly due to the ongoing supply chain-related challenges.

We ended the first quarter with $152.4 million in cash.

Our debt to trailing 12 months EBITDA ratio, which is used for our bank covenants, is approximately 1.3, well below our covenant threshold of 3.5. Our net debt to trailing 12 months EBITDA ratio was approximately 0.4.

Please turn to Slide 11. Fiscal year '23 first quarter free cash flow, a non-GAAP financial measure, was $3.1 million as compared to a use of cash of $6.2 million in the first quarter of fiscal year '22. The increase of $9.3 million was primarily due to favorable changes in net operating assets and liabilities. Lower net income of $7.6 million was offset by a favorable change of $10.6 million in working capital and $6.3 million less in capital expenditures. We expect free cash flow to improve the remainder of fiscal year '23 as we target reduced inventory levels and other positive working capital initiatives combined with increased net income, all while supporting increased CapEx.

Regarding capital allocation. On June 16, we announced a $100 million increase to our existing stock buyback program. During the first quarter of fiscal year '23, we bought back 317,000 shares for $11.9 million, bringing the total program to date purchases of nearly 1.9 million shares, totaling $83 million, which leaves approximately $117 million of remaining capacity available for purchases as of the end of the first quarter. The current authorization expires in June 2024.

Investing for future organic growth and vertical integration remains a key priority from a capital allocation strategy perspective, especially as we rationalize our global footprint for the future, including expanding our EV capabilities so we can better support our build-where-we-sell strategy and continue to better position ourselves to capitalize on the EV mega trend.

We have a strong balance sheet, and we'll continue utilizing it by continuing our investment in businesses to grow them organically. And in addition, we continue to pursue opportunities for inorganic growth, with a measured return of capital to the shareholders.

Please turn to Slide 12. Regarding fiscal '23 guidance, it is based on management's best estimates including the impact of the COVID-19 pandemic, particularly in China, the headwinds from the ongoing semiconductor shortage, other supply chain disruptions, inflation, economic instability in Europe in both short- and long-term supply chain rationalization and restructuring efforts and the related impact on our financial results. All of these items individually and collectively still pose an ongoing challenge in this macroeconomic environment.

While we have experienced some success in recouping some cost recoveries, we expect these headwinds will likely be with us for the remainder of fiscal year '23.

The revenue range for the full fiscal year '23 is between $1.160 billion to $1.210 billion. The anticipated growth at the midpoint of our range considers the full year impact of the large automotive program roll off, which had sales in fiscal '22 in excess of $100 million. The diluted earnings per share range is also unchanged at $2.70 to $3.10, and contemplates the continued above-mentioned headwinds from supply chain inflation and other macroeconomic effects.

Our estimated annual effective tax rate remains between 16% and 18% without any discrete items. We continue to anticipate CapEx of between $40 million and $50 million as we expand our capabilities to support our growth in EV sales and strategically position our global footprint to support production of our significantly increased order backlog that we have built over the last 2 years. Estimated depreciation and the amortization expense remains between $54 million and $58 million. In short, the first quarter was within our range of expectations and our current view of the remainder of the fiscal year remains unchanged.

As a reminder, based on the strong bookings we realized over the past 2 fiscal years, much of which is for the EV market, we announced a 3-year organic compounded annual growth rate of approximately 6%. This CAGR continues -- considers the anticipated roll-off of relevant programs and reinforces that our organic growth strategy is putting the company on a solid future organic growth trajectory. The strong bookings momentum continued in the first quarter of fiscal '23.

Don, that concludes my comments.

Ron, thank you very much. Ali, we are ready to take questions.

(Operator Instructions)

First question is coming from Luke Junk with Baird.

To start hopping we could start with the automotive business. Specifically, I was hoping you could help us unpack the 2 factors you cited behind continued subdued margins in that segment. Is there a good way to think about the relative weighting between the 2 factors that you mentioned? In other words, the major customer roll off in terms of cost absorption and the China-related impacts in the quarter that might speak to the stickiness or perhaps lack thereof of those headwinds in auto margin going forward?

Sure. When I look at the rollout of the program, which we've anticipated for quite some time, I don't put a whole lot of weight to that as we'd several years ago, we booked EV programs that we saw from revenue that replaced that. The impact, even though we did recover some of our costs during the quarter, was from ongoing supply chain issues, both inflation -- wage inflation and logistics. So if those didn't exist in the quarter, we would -- I don't think we'd be talking about the roll off of a program. So those are mutually exclusive.

What impacted auto or the macroeconomic conditions in Europe, which is a higher margin territory for us than in the United States. So the combination of the logistics and inflation and as well as European sales and mix contributes to that.

And I think we'll recover -- we anticipate recovering what was lost "in China". We anticipate recovering that the rest of the year. And it's the stickiness of the items Dan mentioned that we will continue to pursue.

Okay. And then my second question, just regarding the shape of the fiscal year. Overall, you're clearly starting with some improvement in earnings versus where the fourth quarter checkout from here that, of course, is going to need to continue. Back of the envelope, if I do the math, take the midpoint of guidance and what you reported this year -- this quarter, I should say, that implies about $0.77 per quarter in EPS to get to that midpoint. Can you just comment on how you see that progression internally or maybe any key factors we should be considering relative to that anticipated progression on a quarterly basis?

Sure. I'll start off and I'll let Ron make a comment too. But as I mentioned in our prepared remarks, we were impacted in the first quarter by the lockdowns in China as well. So if that had not occurred, we would have had a better quarter. But as we -- Ron, I'll talk, I'll let you say the rest of it.

Yes. No. Look, we anticipate improvement in each of the quarters coming up. I mean, historically, our third quarter tends to be maybe a little bit weaker than some of our other quarters. But we're going to see some momentum coming out of this quarter in terms of the China lockdowns and some of the other programs that will -- that we'll have bringing to launch. You'll see it. We anticipate progressing throughout the year in terms of EPS growth. But we give quarterly guidance, but we did the same math and achieving that on average per quarter is achievable. We're confident in that going forward, short of another lockdown in China.

Okay. And then just one last question, if I can sneak it in here. Don, just wondering if you could comment on the trends in medical this quarter and maybe zooming out more importantly, just your aspirations and outlook for that business here as we look over the rest of the fiscal 2023.

If I look quarter-over-quarter, to be at a very strong quarter in the fourth quarter, $1.6 million in this quarter versus $0.7 million. I don't read too much into that, the fourth quarter at a very large order and actually, a large order, over $0.5 million and then a kind of a mid-sized order. And that's really dictated by when the evaluations are done by the hospital that have been impacted by COVID. And the orders follow usually in the next quarter. So that's what happened in the fourth quarter, which was a great quarter.

The first quarter, we didn't have a completion of any major evaluation. So that's -- that was weaker again. I think what Dabir is experiencing was the long-term effect of COVID on the revaluation. So it kind of makes it order flow a little lumpy. But to your question, what are we expecting in the $4 million to $5 million range and we get the evaluations done. And I mentioned before, we almost always get business after an evaluation. So evaluations have all been successful. So I'm anticipating that the pace for Dabir will pick up.

And to the last part of your question, we remain confident in that business. The list of customers continues to grow. So we -- and we understand the issues that had with evaluations, but we still remain confident in the business.

(Operator Instructions)

Our next question is coming from John Franzreb with Sidoti.

The Industrial business, record revenues. Is there anything unusual as far as timing in the quarter that could help achieve those revenues? Anything else coming in? And what are your expectations on the cadence in the Industrial business for the balance of the year relative to the first quarter.

Sure, John. A couple of things. The CV, commercial vehicle, was strong and continued to grow, which was good for us. Our power -- non-EV power, certainly that serves the data centers, that type of business can be lumpy. And we experienced some nice revenue recorded during the quarter. So a combination of both of those things are probably the biggest impact to the increase in sales.

John, I just -- comfort in that the business continues to grow. And it was impacted by logistics and inflation, but not quite as much as all of the margins were down, but still our biggest segment. So as Ron said, the data center business contributed. But I was pleased to see that our commercial business is quite strong, and the customers continue to book business.

That's good. And Don, last quarter, you kind of expressed, I don't know, concern about having to go back to customers multiple times in the quarter to get price increases because of the -- behind the price cost curve of inflation. Has that abated at all in the first quarter? Or are you still finding yourself in a situation where you're going to have to go back again and again and it elongates your recovery process.

That still exists. It's a delicate conversation with customers. We're careful how we do that, but it is a necessity. And as I said in my prepared remarks, as long as inflation continues, we're going to be behind the 8 ball in any given quarter, you're recovering from maybe the previous 2 quarters, but now you've got another increase, and you have to go back for that. So that's a hamster wheel. And until inflation subsides, we're going to be fighting that. Customers, and I understand that we're not going to give anticipatory price increases on inflation. We wouldn't do it either. So that continues, to be direct on your question. That continues.

Okay. Fair enough. And I guess 2 parts, I guess, to this question. You sort of a lockdown in China than (inaudible). Can you, a, hit your 20% EV target without China coming back to some normality, and b, given the additional lockdowns we've heard of today, is that kind of factored into your outlook? Or are you a little bit surprised by that?

I don't know that we were surprised by it. We did anticipate some in review of the balance of the year. But that really is the unknown. If next week, Shanghai gets locked down or along that, that will have an effect on us. To what degree, we do live inventory. We have a product on the water, unfortunately, that contributes to inventory. But that is the biggest factor even more so than maybe the macroeconomic conditions in Europe.

And regarding the EV target, do you need China to come back to it? Or can you hit that regardless?

I think we can -- if your question is if it stays status quo, can we get the target and our projections are, yes. Again, I don't need to repeat myself, but affects one of our plants dramatic, that will have an effect.

Okay. Great. And I guess one last question on capital allocation. Just talk a little bit about your decision to buy back shares versus for reduction of debt and M&A. What are your kind of general thoughts at this point? Any kind of additional color would be helpful.

Sure. Sure, John. We assertively and continue to look at inorganic growth targets as we have in the past. So that posture has not changed at all. Yes, we did only reduce debt by $3.1 million during the quarter. But that was consciously. We chose to buy back shares. The debt that we have, especially our term loan A debt, if you pay that down, you can't reborrow against that. So it was a great time for us, we thought, to continue our share repurchase after announcing the additional $100 million. We wanted to act on that. And we thought that had a priority over the -- any further reduction in debt.

And as far as acquisitions, this is something that we continue to look at. Some of the acquisitions that we have on our list, we really want to see what happens in the world economy. That will certainly affect the valuation of those companies. And I think in general, the M&A market is maybe taking a bit of a pause, see what happens with interest rates and economic conditions, particularly in Europe right now.

As there are no more questions in queue, I will hand it back to Mr. Duda for any final comments.

Ali, thank you. Well, thanks everybody for listening and wish everybody a safe and enjoyable later day weekend. Goodbye.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.