Methode Electronics, Inc.

Good day, ladies and gentlemen, and welcome to the Methode Electronics Fiscal Year 2020 First Quarter Conference Call. For this quarterly conference call, the company has prepared a PowerPoint presentation entitled Fiscal 2020 First Quarter Earnings, which can be found at Methode.com in the Investor Relations section. As a reminder, this conference is being recorded. This conference call does contain forward-looking statements, which reflects management's expectations regarding future events and operating performance and speaks only to as to the date hereof. These forward-looking statements are subject to a safe harbor protection provided under the securities law. Method undertakes no duty to update any forward-looking statements to conform these statements to actual results or changes in Method's expectations on a quarterly basis or otherwise. Four looking statements in this conference call include a number of risks and uncertainties. The factors that cause these actual results to differ materially from our expectations are detailed in methods filings with the Securities and Exchange Commission, such as our annual and quarterly reports. Such factors may include, without limitation, the following. Number one, dependence on a small number of large customers, including two large automotive customers. 2. Dependence on the automotive, appliance, commercial vehicle, computer, and communications industries 3. International trade disputes resulting in tariffs and our ability to mitigate tariffs 4. Timing, quality, and cost of new program launches 5. The ability to withstand price pressure, including pricing reductions 6. Ability to successfully market and sell labor services products 7. Currency fluctuations 8. Customary risks related to conducting global operations 9. The ability to withstand business interruptions 10. Recognition of goodwill impairment charges 11. Ability to successfully benefit from acquisitions and divestitures 12. Investment in programs prior to the recognition of revenue 13. Dependence on the availability of price of materials 14. Fluctuations in our gross margins 15, dependence on our supply chain 16, income tax rate fluctuations 17, ability to keep pace with rapid technological changes 18, breach of our information technology systems 19, ability to avoid design or manufacturing defects 20, ability to compete effectively 21, ability to protect our intellectual property 22. Success of GRAECON and or our ability to implement and profit from new applications of the acquired technology 23. Significant adjustments to expense based on the probability of meeting certain performance levels in our long-term incentive plan 24. Costs and expenses due to regulations regarding conflict materials All lines are placed on a listen-only mode for today's call, and the floor will be open for your questions and comments following the presentation. If you should require assistance throughout the conference, please press star zero. At this time, it is my pleasure to turn the floor over to your host for today, Mr. John Duda. Sir, the floor is yours.

Thank you, Jess, and good morning, everyone. Thank you for joining us today for our fiscal 2020 first quarter financial results conference call. I'm joined today by Ron Zuma, our chief financial officer, Both Ron and I have comments, and afterwards we will take your questions. To start, I will ask you to turn to slide four. Our strong first quarter results, which include record sales as well as record EBITDA, were attributable to both sales growth and operational efficiencies. The automotive segment outperformed relative to the global automotive market, which continued to weaken during the quarter. Importantly, the segment's organic revenue decline slowed to just 1.4% year over year, the lowest level in four quarters, versus a global automotive volume decline of about 10%. Additionally, we saw the benefit of the initiatives we took last year to reduce costs and improve profitability, as well as successful tariff recovery efforts. Ron will cover this more in his detailed remarks. Also during the first quarter, new business wins and business development efforts in both automotive and industrial segments continue to capitalize on important trends, including safety and electrification. Finally, at DeBeer, we continue to add new customers and made significant progress in lowering the average evaluation time. Turning side five for a few comments on our key financial metrics, year over year, consolidated sales improved 21%, in line with our internal expectations. Additionally, GAAP net income improved 19% while adjusted net income, which excludes expenses for initiatives to improve operations and acquisition-related expenses in the applicable period, improved 14%. On slide six, you can see our automotive segment is successfully navigating some significant industry and macro headwinds. While our Asian operation is affected by the decline in passenger car sales and the ongoing trade and tariff dynamics, the fact that our exposure to domestic Chinese OEMs is limited to 8% of sales has somewhat mitigated the impact of these macro factors. Additionally, we believe new products launching during fiscal 2020 should help us offset these headwinds. In fact, in Europe, the new launches have nearly offset the effect of the economic uncertainty and revised GDP forecasts. Graycon Sales of Tesla, as well as new launches and the strong mix of products for SUVs and pickup trucks have bolstered the North American operation. It is important to note that the new launches I just mentioned will continue to ramp throughout the next three quarters. Please turn to slide seven. Our book business incentives grew 11% year over year, and it's anticipated to grow from 56 million this year to over 94 million by fiscal 2022. further validating our strategy to move the company into higher margin technology business. Our highly patented magneto-elastic technology also provides steering assist on sport and recreation vehicles and clutch plate position for automobiles as well as active role control to improve safety. Moving to slide A, our portfolio of technologies and solutions for the hybrid and electric vehicle market and RGB LED-based ambient and direct lighting led to a solid quarter of new business awards totaling 30 million. European Automotive was awarded Jaguar Land Rover's Common Architecture Program. JLR's strategy to create common modules and standardize in all future electric and hybrid vehicles within their portfolio utilizes our power-operated tailgate switch, steering paddle shift, as well as glove box and instrument panel switches. With a five-year program life, annual revenue was $5 million, launching in the second quarter of fiscal 2021. GRAECON was awarded additional content on Rivian's electric pickup and electric SUV models, the Reading Council lamp and the footwell and floor tray lamps, launching in the second quarter of fiscal 2021. With these new awards, total content per Rivian vehicle between Greycon and Pacific Insight is $188 for the pickup truck and $228 for the SUV. Greycon was also awarded the Tesla Model Y combination coat hook reading light with estimated annual revenue of $3 million, launching in the third quarter of fiscal 2020. With this award, total content per vehicle across all Method businesses for the Tesla Model Y is $160. Notably, for the Tesla Model S and X, Method's total content per vehicle has grown to $300. Our automotive group in Asia was awarded $11 million for bus bars on two current electric transmission programs, both beginning in the third quarter of fiscal 2022. The bus bars are for PSA's new DS3 Crossback and Hyundai's LaFesta and Insignia vehicles. Additionally, Nissan Mitsubishi awarded a bus bar program for an electric vehicle with average annual revenue of $11 million, launching the second quarter of fiscal 2021. Pacific Insight and Greycon's lighting technologies and capabilities, together with Methode's expertise in both power distribution solutions and automotive manufacturing, will provide opportunity for market share gains and increased content across Methode. Moving to an update on DeBeer. During the first quarter, we added five new customers, including our third pediatric hospital. Additionally, our evaluation time for systems at hospitals averaged 48 days in the first quarter, down from 77 days in the first quarter of last year. We also began the first evaluation using our Gen 2 system at a Midwest hospital network in the ICU. Our Gen 2 system was designed for the patient care areas of the hospital, that is, care areas outside the operating room, It has the same therapeutic characteristics as the Gen 1 system, yet is more compact and lightweight and provides the bedside clinician with more display information such as remaining surface life. It also has an auto brightness feature so patients can sleep better at night. In closing, our performance in the first quarter gives us confidence in our full year outlook and ability to execute in a very challenging macro environment. At this point, I'll turn the call over to Ron who will provide additional detail on our financial results and review guidance.

Thank you, Don, and good morning, everybody. Please turn to slide nine. First quarter sales improved 20.9% or $46.8 million to $270.2 million in fiscal 20 from $223.4 million in fiscal 19. Sales from Greycon and new automotive launches more than offset overall market weakness in Europe and China, as well as lower radio remote control, appliance, and data solution sales. Foreign currency exchange continued to be a headwind as the euro and renminbi exchange rates were weaker than the prior year. Moving on to slide 10. On a GAAP basis, first quarter net income increased $4.6 million to $28.3 million, or 75 cents per share, from $23.7 million, or 63 cents per share, in the same period last year. First quarter GAAP net income benefited from the results of GRAECON and the net benefit we received from initiatives to reduce costs and improve profitability from last year, which included the absence of the expense for those actions we had. Negatively impacting first quarter GAAP net income were lower radio remote control appliance and data solution sales, higher expenses for net interest, intangible amortization, income tax, stock-based compensation, and net tariffs, as well as the impact of foreign currency translation. Our first quarter tax rate of 20.5% was impacted by discrete items recorded during the period. Excluding the impact of these discrete items, our first quarter tax rate would have been approximately 16.5%, which is comparable to the first quarter of last year. Our expected rate for the remainder of the fiscal year is expected to be lower than we experienced in the first quarter. Therefore, in spite of a higher than anticipated effective tax rate in the first quarter, We now estimate that our tax rate will be in the range of 18 to 20% in fiscal 2020, slightly lower than the 18 to 21% rate announced in June. China tariffs continue to be a headwind, although we're aggressively working to mitigate the impact on our results. In the first quarter, our net tariff expense of 0.3 million also included tariff revenue reimbursement offsets related to fiscal 19, which were agreed to during the first quarter by some of our customers. Therefore, the amount recognized in the first quarter does not represent a run rate for the remainder of the year. We expect the net impact of tariffs to be higher for the remaining quarters of fiscal 20, but lower than the 8.5 million net expense we estimated during our fiscal 19 earnings call. We also are closely monitoring the announcement from last week that tariffs could increase to 30% from 25 beginning on October 1st. Currently, we believe tariffs for the fiscal year will be in a range of $4.5 million to $5.5 million at the current 25% tariff rate. Moving to margins on slide 11. First quarter GAAP gross margins and non-GAAP adjusted gross margins improved 120 basis points year over year in fiscal 20. Gross margins improved due to Greycon sales, partially offset by the negative impact of foreign currency translation and reduced electronic sales. Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce costs and improve profitability in the applicable period. First quarter GAAP selling and administrative expenses as a percentage of sales decreased 120 basis points year over year, positively impacted by the absence of the expense for operational improvements and the benefit of those improvements, lower acquisition costs, and foreign currency translations, and by selling an administrative expense attributable to GRAECON, which is lower as a percentage of sales than Method as a whole. Non-GAAP selling and administrative expenses as a percentage of sales, which exclude acquisition-related costs and expense for operational improvements, still improved 60 basis points year-over-year in the first quarter of fiscal 20. Shifting to EBITDA on slide 12, the company generated a record $50.3 million in the fiscal 21st quarter, or 18.6% of sales. versus $36.8 million or 16.5% of sales in the same period last year. However, adjusting for expenses for initiatives to reduce overall costs and improve operational profitability and acquisition-related costs in the applicable period, first quarter 2019 adjusted EBITDA was $38.2 million or 17.1% of sales. A few additional items to review. Year over year, intangible asset amortization expense in the fiscal 21st quarter increased 2.9 million, or 152.6%, to 4.8 million, primarily through the amortization expense related to the Grey County acquisition. In fiscal 21st quarter, we had invested approximately $13 million in CapEx, mainly to support programs and launches in North America and Europe. Expense for depreciation and amortization for the fiscal 21st quarter was $11.8 million. Let's move to slide 13. Free cash flow for fiscal 21st quarter was $26.9 million. Our debt to EBITDA ratio, which is used for our bank covenants, is approximately 1.6. We paid down nearly $11 million in debt during the quarter, and since purchasing Greycon, we've reduced our debt by $85 million. We ended the quarter with just over $73 million in cash. Move to slide 14. I'll finish up my remarks with guidance. As a reminder, the guidance ranges for Fiscal 20 are based upon management's expectations regarding a variety of factors and involve a number of risks and uncertainties, which have been detailed in this morning's release and the Form 10-Q and our Form 10-K. As we announced this morning, we affirmed Fiscal 20 sales in the range of $1.13 billion to $1.17 billion. Pre-tax income in the range of $150.3 million to $164.3 million and earnings per share in the range of $3.25 per share to $3.55 per share. As discussed during our last earnings call, the majority of our new automotive and e-bike program launches will not be at full production volumes until the second half of the fiscal year. Additionally, the laundry care program is anticipated to launch in our fiscal third quarter. While our estimated tariff expense is now potentially lower than originally anticipated, market shoppiness related to a number of industry-wide and macro headwinds will continue to impact our fiscal year. These include the shift away from sedans and traditional passenger cars, the dollar strengthening against most major currencies, and the anticipated softening in the commercial vehicles markets in the second half of our fiscal year. For fiscal 20, we are estimating capital investment to be in the 48 to 54 million range and depreciation and amortization to be between 51 and 54 million. Lastly, we expect our fiscal 20 free cash flow to be between $122 and $136 million. In conclusion, please move to slide 15 to look at the key drivers of our anticipated EBITDA performance for fiscal 20. Looking at EBITDA based on our $155 million of EBITDA in fiscal 19, Adding EBITDA from new automotive and laundry program launches of about $19 million. Adding EBITDA from a full year of Greycon, which is about $21 million. Subtracting the impact of the loss of EBITDA from reduced passenger car production, which we estimate to be around $14 million. Adding the benefit of the initiatives to reduce cost and improve profitability of about $11 million. and adding back the one-time costs we incurred in fiscal 2019 for acquisitions and restructuring of about $29 million. Done. That concludes my comments.

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

Certainly. Ladies and gentlemen, if you have a question or comment, it is star 1 on your telephone. We do ask that if you're using a speakerphone, you pick up your handset to provide the best sound quality. Once again, ladies and gentlemen, star one for any questions. We'll pause just a moment to assemble the roster. We'll go first to Chris Van Horn at B. Reilly FBR.

Good morning. Thanks for taking my call and congrats on the quarter. Good morning, Chris. I just want to dig a little bit deeper, if we could, on the award activity, because it seems like you had a strong quarter in terms of awards across the board here. Any sort of drivers that stuck out to you, either from a competitive standpoint or just from a customer pickup perspective? Sure.

We've said this in the past. Method is somewhat unique in that we are a seasoned automotive manufacturer and we are in the bus bar business. And so our awards under the roof, I think half probably were in electrification, come from that fact. We've supplied Tesla for a number of years. We've got a good track record there. So it's not necessarily surprising that we are getting other business. We've announced wins with Volkswagen. and then we've got Rivian and several others. So I think that makes us somewhat unique. And then, you know, some of the lighting wins is just Greycon doing a good job of booking business and Methoda as well. And some quarters are better than others. This was a good booking quarter. I think last quarter was a little lighter, but it was a nice quarter. 30 million of wins. Hitting 21 and 22 will definitely help us have organic growth.

Okay, got it. And then maybe on that point, I remember when you made the Greycon acquisition, there was a lot of possibilities or opportunities, if you will, to get with your existing customers who you were supplying customers. as well as kind of showcase some of the maybe traditional method capabilities to some of Greycon's customers. Have you seen that come to fruition?

We've done – I think we talked about it last quarter. We've done tech days for many of the key customers. That has given us opportunities. We've had some nice opportunities that we're working on, but at this point nothing major to announce. But we are – we're seeing progress there for sure.

Okay. I did notice during the quarter, it seems like acquisition-related costs and profitability improvement costs came down, almost eliminated, if you will. Do you see that coming back up in the out-quarters for the year, or do you feel like you've kind of made all the moves that you need to make in that department?

Yeah. Let's talk about acquisitions first. I mean, obviously, if we did an acquisition, we'd have some additional acquisition costs, but we have nothing pending that would significantly impact the P&L. And last year, very quickly, we took actions to reduce our costs as soon as we saw the declining revenues. Again, we have nothing planned this year, so we don't anticipate any costs there, but, you know, Very challenging environment, so I wouldn't rule that out if things went or declined further, but we have nothing planned.

Okay. Okay. And then I guess last for me, you know, the free cash flow profile is looking really strong. You know, maybe two-part question. One, is that CapEx number that you gave us majority growth CapEx? And then two, with this free cash, what are your kind of plans going forward, dividend, share purchases, et cetera?

The majority of the 48 million is for growth. And as you know, all the programs take a fair amount of capital to launch and we've got launches going on throughout the year here. So that's a good portion of that. I'm drawing a blank on that. But we use them for gas, yeah, I'll let you answer that.

Yeah, so we're certainly looking at just growing our business, deleveraging until we're going to support organic growth. and to support the growth of the business and possible future acquisitions. And until then, you know, just deleverage. So no, you know, we pay a quarterly dividend and have for many years and we will continue to return capital to the shareholders in that regard. But mostly we would focus on future growth, organic and inorganic.

Yeah. And our until we find Thank you, Chris.

A quick reminder, it was star one if you had a question or comment. We'll go next to Steve Dyer, Craig Hallam Capital Group.

Hey, guys. Ryan Signal on for Steve. Good morning. So you mentioned the Generation 2 DeBeer system for patient care areas outside of operating room. Do you expect a similar ramp, I guess, as the legacy product there? Or are there different structural dynamics between an operating room versus other patient

and the rest of the patient care areas of a hospital? No. Gen 2 was developed, as we said, for the patient care areas, but also to go into post-acute. It's a more advanced system that we have with Generation 1. Generation 1 will continue to be used in operating rooms. We're not obsoleting that. We felt that we needed a smaller, and a portion of Gen 2 is a battery operated lithium ion. So it doesn't really change the basic therapeutic value. It's just a different controller.

So there's no reason to believe that you could launch faster or expand into hospitals quicker with this new Generation 2 product?

It was designed with a lot of input from post-acute and what we learned from Gen 1. I don't think that would accelerate the beer's adoption. DeBeer, as we've said, is a design and sell. You really have to go in and prove the efficacy of the product, whether it be Gen 1 or Gen 2.

Yeah, go ahead.

Let me make one other point there. When you go into ICU and you go into med surg, there are obviously more beds. So there's a larger available market. But again, I don't think the Gen 2 enabled that. It's just us doing the designing that we continue to do in the operating rooms. I'm sorry, I interrupted you.

Yeah, no, I was just going to ask one. So presumably the Gen 1 in the operating room has proved out the efficacy and etc., Will that carry over or do you need to go kind of start from step one here with this product or can you use some of that, leverage some of that previous experience there with this product?

In a hospital that has used Gen 1 in the operating room? No, you don't have to go through another trial. The efficacy is proven now. We're doing a trial now in a new hospital system, and they decided they wanted to use it in ICU first versus operating room. And again, that's a new opportunity, so it's a new trial. But presumably that trial will be successful if they wanted to use it in another area. If they wanted to go into the operating room, they wouldn't do another trial.

Got it. I'll leave it there with the beer. Switching over to industrial, margins were really solid, 37.4% in the quarter. Where do you think that can go over the next few quarters, kind of with all the cross-currents with a bunch of synergy potential, but also softening the commercial market, etc.?

That's a very good question. We are going to see softening of the commercial market as we build into our second half. that does impact margins. We have a number of cost improvement programs going on, particularly in our Chinese operation for Greycon. Some of those will offset that Thank you. Thank you. We'll hold our own, let's put it that way, by the initiative. That was our design.

Yeah, I would just add to that maybe that the electronic is part of that group, too, as well. So any headwinds there, you know, could degrade the margins a little bit. It was a great quarter, as you noted, over 37% margin. And I think our target, you know, we had a low to mid-30s, so that's – We really, we crushed it this quarter for sure.

And we have seen some softening in the electronic European business. Now, we think that will continue into the second quarter. We'll see what happens in Q3 and Q4. But we've seen some softening there. That's a very good margin product for us. So if we see decline, then that obviously affects margins too.

And maybe just to clarify, I think I heard two different things here that, you know, this year, I realize all the headwinds, but potentially that margins could expand, you know, next year fiscal 21 and going forward. But I also heard kind of low to mid 30% gross margin.

So maybe I guess... Well, I think that's what we've communicated. Yeah, we've communicated as our target.

As the target this quarter was obviously higher than that. But as I said, there's pressures on that margin.

Got it. Last one for me, and then I'll turn it over. So on slide eight, showing the content on the two different EV vehicles, between 200 and 300 bucks, maybe how does that compare to a different platform, say GM's truck and SUV platform?

If I look at the average sale price on, and right now we're a combination of K2 and T1, it's around $150 on a lot of volume. But what we've seen with PI, with Greycon and our own bus bar business, we've been able to add content to these vehicles quite nicely. Now, again, it's not the 700,000 units you see from GM, but the average sale price is higher. And the margin is better.

Great. Thanks, guys, and good luck. Thank you.

Mr. Duda, at this time I have no other questions holding. I'll turn the conference back for any additional or closing remarks.

All right. Thank you, Jess. We'll thank everyone for listening and have a very safe and enjoyable Labor Day weekend.

Thank you. Ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may disconnect your phone line at this time and have a great day.