Methode Electronics, Inc.

Good day, ladies and gentlemen, and welcome to the Method Electronics first quarter fiscal 2022 results conference call. All lines have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. If you should require assistance throughout the conference, please press star zero on your telephone keypad to reach a live operator. At this time, it is 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 Metho Electronics Fiscal 2022 First Quarter Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2022 First Quarter Financial Results, which can be viewed on the webcast of this call or found at metho.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. Method undertakes no duty to update any forward-looking statement to conform the statement to actual results or changes in Method'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 methods 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 a fiscal 2022 first quarter earnings conference call. I'm joined today by Ron Zumis, our chief financial officer. Both Ron and I have opening comments, and then we will take your questions. Let's begin with the business highlights on slide four. Our sales for the quarter were $288 million. Excluding favorable currency translation, our organic growth was up 45% from the prior year. However, it should be noted that our prior year first quarter was significantly impacted by the pandemic. In this year's first quarter, our team faced customer demand fluctuations and supply chain challenges. These included the ongoing semiconductor chip shortage, pandemic-related supply chain disruptions, and port congestion, all of which created both sales and margin pressure. Once again, our team worked diligently to mitigate many of these challenges, and we were able to deliver results within our guidance ranges for the quarter. However, these demand fluctuations and supply chain disruptions continue to require remedial actions such as expedited shipping and premium component pricing. As of today, our expectation is that these conditions will last at least until the end of the calendar year. While we have reaffirmed our guidance for the full year, Persistent headwinds could cause our performance to be below the midpoint of the ranges as the situation is very fluid and will remain very challenging. The sales growth that we realized in the first quarter was due to increased demand across most of our businesses, but it was especially focused in the auto and commercial vehicle markets. We also realized growth in our DeBeer business. However, that business is still being hampered by the pandemic, thus limiting our production or product evaluation opportunities in hospital operating rooms and ICUs. On an order basis, we had solid awards for EV, cloud computing, and e-bike applications. Focusing on EV, last quarter, we reported that sales into EV applications were 13% of consolidated sales. This quarter, EV sales were 16% of consolidated sales, and we continue to expect that number to be in the meetings for fiscal 2022. Method's combination of user interface, LED lighting, and power distribution solutions is a winning formula in EV. We are especially seeing growth in our power offerings, where we leverage over 40 years of expertise to supply bus bars, connectors, and battery disconnect units to the EV OEMs. In the quarter, we further reduced debt, generated positive operating cash flow, and continued to return capital to our shareholders. We have ample liquidity, which also allows us to execute our stock buyback program, under which we purchased $7.6 million of shares in the quarter, and to pay our dividend, which rose from 11 cents to 14 cents per share in the quarter. We continue to allocate capital per our balanced approach. Moving to slide five, Methyl had another solid quarter of business awards. These awards continue to capitalize on key market trends like vehicle electrification, and cloud computing. The awards identified here represent some of the key business wins in the quarter and represent over $30 million in annual business at full production. In vehicle electrification, we won awards for power distribution and LED lighting programs. We continue to win programs with OEMs globally in both auto and commercial vehicle applications. In non-EV automotive, We were awarded programs for power, lighting, and traditional switch applications. In cloud computing, we saw demand for our power distribution and transceiver products and data center applications. Lastly, we continue to participate in the growth of e-bikes, which utilizes our proprietary magneto-elastic sensor technology. Building on the prior year, our business awards are delivering on our strategic priority to drive both customer and geographic diversity. Turning to slide six, as I've mentioned in recent quarters, our business awards over the last couple of years have put us on track in aggregate to replace the sales from the roll off of our largest auto program. As such, our customer and program diversity continues to improve. Our EV as well as our commercial vehicle and cloud computing businesses have helped drive our customer diversification. While GM and Ford have been and are expected to continue to be good customers that have fueled methods of historical growth, in recent years we have strategically and systematically broadened our customer base. Our business outside of GM and Ford grew to two-thirds of our fiscal 2021 total sales. To conclude, despite the ongoing demand fluctuations and supply chain challenges, we are still in a position to deliver strong organic growth for fiscal 2022. At this point, I'll turn the call over to Ron, who will provide more detail on our first quarter financial results. Ron.

Thank you, Don, and good morning, everyone. Please turn to slide eight. First quarter sales were $287.8 million in fiscal year 22 compared to $190.9 million in fiscal year 21, an increase of $96.9 million, or 50.8%. The year-over-year quarterly comparisons include a favorable foreign currency impact on sales of $10.3 million in the current quarter. The increase was mainly due to lower sales in the prior year quarter from the impact of the COVID-19 pandemic and to higher sales of electric and hybrid electric vehicles, which amounted to 16% of sales in the first quarter of fiscal year 22, which was in line with our previous communication that electric vehicles and hybrid electric vehicle sales would comprise mid-teens of our fiscal year 22 consolidated sales. In addition, stronger commercial vehicle sales contributed to the robust sales growth. First quarter net income increased $8.4 million to $29.1 million, or $0.76 per share diluted. from 20.7 million or 54 cents per diluted share in the same period last year. Net income benefited from increased sales and favorable currency translation partially offset by higher income tax expense, higher costs from supply chain disruption, higher selling and administrative expenses, and lower other income. Please turn to slide nine. First quarter gross margins were higher in fiscal year 22 as compared to fiscal year 21, mainly due to increased sales partially offset by higher material costs, higher logistic costs, including freight and supply chain shortages. Fiscal year 22 first quarter margins were 24.9% as compared to 23.6% in the first quarter of fiscal year 21. The negative impact of the supply disruption and higher logistics costs, including freight, on the first quarter of fiscal year 22 gross margin was nearly 300 basis points. These higher costs that were experienced in the first quarter are expected to continue further in fiscal year 22. In addition, we anticipate a degree of cost inflation in the remainder of the current fiscal year. First quarter selling and administrative expenses as a percentage of sales decreased to 11.4% compared to 13.9% in the fiscal 21 first quarter. The fiscal year 22 first quarter percentage decrease was attributable to increased sales related to the negative impact of COVID-19 pandemic on fiscal 21 sales, partially offset by higher stock-based and performance-based compensation expenses. The first quarter fiscal year 22 selling and administrative expenses percentage was in line with our historical norm, which should yield an efficient flow through from gross margin to operating income. Please turn to slide 10. In addition to the gross margin and selling and administrative items mentioned above, Two other non-operational items significantly impacted net income in the first quarter of fiscal year 22 as compared to the comparable quarter last fiscal year. First, income tax expense in the first quarter of fiscal year 22 was $5.7 million or 16.4% as compared to a net tax benefit of $5.1 million in the first quarter of fiscal year 21. The effective tax rate was lower in the first quarter of fiscal year 21 due to discrete tax benefits of $7.8 million in the quarter, or 20 cents per diluted share. Without the discrete tax benefits, the effective rate would have been 17.2%. The year-over-year tax expense increase was $10.8 million. Other income net was lowered by $1.6 million, mainly due to lower international government assistance between the comparable quarters. Shifting to EBITDA, a non-GAAP financial measure, fiscal year 22 first quarter EBITDA was $48.5 million versus $29.3 million in the same period last fiscal year. EBITDA was positively impacted by higher operating income, partially offset by lower other income. Please turn to slide 11. Free cash flow, a non-GAAP financial measure, is defined as net cash provided from operating activities minus CapEx. For fiscal year 22 first quarter, free cash flow was a negative 6.2 million as compared to a positive 4.8 million in the first quarter of fiscal year 21. The decrease was mainly due to negative working capital changes, especially inventory, resulting from difficult logistics and higher capital expenditures. While we experienced negative free cash flow in the first quarter of fiscal year 22, we expect improvement the remainder of the fiscal year. We anticipate continuing our proven history of consistently generating reliable cash flows, which allow for ample funding of future organic growth, inorganic growth, and return of capital to the shareholders. In the first quarter of fiscal year 22, we invested approximately $15.9 million in CapEx as compared to $11.6 million in the first quarter of fiscal year 21. The higher first quarter CapEx is in line with our expectation that CapEx in fiscal year 22 would be higher than the investment in the prior year, estimated to be in the range of $53 to $57 million. We have a strong balance sheet. and we'll continue utilizing it by continuing investment in our businesses to grow them organically in the future. In addition, we continue to actively pursue opportunities for inorganic growth and have a measured return of capital to the shareholders. In the first quarter of fiscal year 22, we reduced gross debt by $4.7 million. Since our acquisition of Greycon in September 2018, we reduced gross debt by nearly $123 million. Regarding capital allocation, we recently announced two initiatives. First, on March 31st, we announced a $100 million share repurchase program, which we executed 7.6 million of repurchases during the first quarter of fiscal year 22. Since the authorization's approval, we have purchased 15.1 million worth of shares at an average price of $46.45. In addition, We increased our quarterly dividend from 11 cents to 14 cents per quarterly share, an increase of 27%. We ended the first quarter with $207.9 million in cash. Please turn to slide 12. As Don mentioned in his remarks, we reaffirmed our previously issued guidance and earnings per share annual guidance. Guidance is based on management's best estimates. External events and their related potential impact on our financial results remain an ongoing challenge. While we have reaffirmed our guidance for the full year, persistent headwinds could cause our performance to be below the midpoint of the ranges as the situation is fluid and will likely remain very challenging. The revenue range for the full fiscal year 22 is between $1.175 to $1.235 billion. Diluted earnings per share range is between $3.35 to $3.75 per share. The range is due to the uncertainty from the supply chain disruption for semiconductors and other materials on both Method and its customers. From a sales perspective, lower sales could result from the supply disruption to us and or our customers, which could result in lesser demand for our products or our ability to meet customer demand. Continued supply chain disruption would also negatively impact gross margins due to additional costs incurred from premium freight, factory inefficiencies, and to a lesser extent, tariffs and other logistic factors, including port congestion. Higher costs for materials, freight, and labor are a constant and dynamic battle, and we are uncertain as to when things will stabilize. Don, that concludes my comments.

Ron, thank you very much. Kat, I believe we're ready to take questions.

Certainly, thank you. The floor is now open for questions. If you do have a question, you may press star 1 on your telephone keypad at this time. If your question has been answered, you can remove yourself in the queue by pressing 1. Again, ladies and gentlemen, it's star 1, and our first question comes from... I'm sorry. Our first question comes from Matt Sheeran from Seifel. Go ahead, Matt.

Yes, thank you. Good morning, everyone. Just a couple of questions for me. First, regarding your guidance for the fiscal year, sounds like, you know, you're reaffirming that, but a little bit more cautious due to some of the headwinds that you see on the supply side. So, are you seeing, you know, less visibility into demand because of those issues? Are things getting worse than they were? Just want to sort of understand why you found a little bit more cautious relative to last quarter.

I think what I can point to is GM's announcement this morning on additional plant shutdowns. We were anticipating some of that, and that's really what causes us to say we're going to see enough fluctuation here in uncertainty that if that were to continue, we would be off the midpoint of our guidance ranges. we still remain confident in the range. It's just, as you mentioned, the uncertainty causes us to be perhaps more cautious than we were at the beginning of the fiscal year. I think that's fair to say.

Yeah, I understand. In terms of how you see sort of the fiscal year playing out, I think typically you're up a little bit in the October quarter sequentially, but would it be more flattish just because of those near-term headwinds Obviously, GM's not the only one. We're hearing about shutdown. IHS has been cutting its numbers every month, it seems. So, I mean, are you expecting things to sort of stall here before they pick up again?

I think the word is lumpy. I think we're going to see some good months as some of the supply chain issues abate, Alternate materials that everyone is working on come into play. But I don't think we can look at the business historically and say, you know, in October or February is going to be, you know, going to be better based on history. If you look at the dealer lots, they're empty. So the moment they can build cars, we're going to get business. So if that happened in December, which is usually a slower month, then we'll see an uptick in the December timeframe. It's the unpredictability that is going to make the foreseeable future, the revenues, I hate to use the word, but lumpy.

Yeah. Okay. And just lastly, regarding the gross margin headwinds that you're not the only one seeing, Are you having any success talking to your customers about passing some of those costs along?

We're having some success, but I would say it's limited. Ultimately, we're pretty persistent. We'll have some success in that, but in the past, it could take us six to eight months to come to an agreement with the customer on that. It took that on tariffs.

Yeah, I think the key thing is we incur them, and there's going to be a degree of latency between any type of recovery, and it will be a little bit mismatched. But as Don mentioned, we're persistent and working with our partners as best we can.

And it's a cycle. As we bid new business, we're taking all that into account, I'm sure as our competitors are too. So that will eventually get passed on. There's a lag.

Okay. All right. Thanks so much. Thank you.

Again, ladies and gentlemen, it's Star 1 to ask a question. And our next question comes from from . Go ahead.

Good morning, everyone. Thanks for taking the question. I'll start with a question probably for Ron. Recently, you've given us guidance for the next quarter. I would appreciate why you didn't do that today, obviously, the GM announcement and whatnot this morning, but was hoping you could maybe walk through any key factors sequentially that might help to bridge from the fiscal first quarter to what you're thinking might be likely internally for the second quarter just at a high level.

Yeah, notwithstanding any GM items that would result from today's announcement this morning, yeah, I think we've got a good, strong backlog in terms of visibility to our commercial vehicle business. Vehicle electrification continues to go well. So we do have some other areas that have firmed up relative to where we are in the first quarter. We clearly, you know, would expect the second quarter to have some momentum relative to the first quarter.

Okay, and then... We chose not to... But generally, METLA doesn't give quarterly guidance. We felt that there was enough uncertainty going into a new fiscal year and the first quarter that we wanted to level set things, which we did. And then, of course, on the call here, we gave comment to... what pressures we're seeing in the second quarter and the balance of the year.

Okay, I appreciate that. Next question I had. You called out a 300 basis point headwind to gross margin around these various supply chain and product-related issues this quarter. That's up versus, I think it's at 200 basis points last quarter. Just wanted to dig into that a little bit further in terms of where you saw changes in terms of increased pressure there, and maybe if you could also expand on how that sets up going forward based on what you know right now.

Clearly, there's a logistics standpoint that really hurt. The port congestion, we manufacture a good amount of our Greycom products in China that have to be shipped, and they're in containers. And so our air freight continues to meet the customer demands, continues to escalate relative to where we were in the first quarter. We're also seeing a lot of spot buy increases in terms of pricing and able to compare components and to secure them. I'm seeing some significant material cost inflation as well. So those are the major things that are going. And you can see, Luke, the other thing I'll add to that besides the 300 basis points is you saw our inventory increase a lot during the three months as well. So it really has got exacerbated in the first quarter. And we hope to see some improvement in that. But port congestion is a real problem, getting our goods out of our facilities in China and getting them to the rest of the world.

And then what? Excuse me. we've increased our surveillance on counterfeit components. We've always had a system in place for that, and we're more comfortable when the components come directly from the manufacturer, but as Ron was mentioning, spot buys, sometimes with your distribution, and we've increased our surveillance because that represents a heightened concern when you're not going directly to the factory all the time. So there's a cost associated with that.

And then, yeah, my last question, bigger picture one, and what I'm wondering if there's any updates in the last three to six months, let's say, on some of the emerging opportunities that you're pursuing. I'm thinking areas that you've mentioned in the past, like charging ports, other areas around power in general, total load sensors, cameras, those sorts of things.

I don't know if we have anything to update other than what we've mentioned in the awards. We continue to pursue the charge ports. That's a big focus for us, but as of today, we don't have any awards that I can announce, but that is an area that we are clearly focused on.

Luke, we're still seeing very robust RFQ opportunities for our bus power and power products regarding vehicle electrification. Those opportunities to quote and to win business are still very robust, though they might not show up as a booking for another six, nine, or 12 months.

Yeah, and I think we remain all cautious. We are excited about the newer OEMs. We're on lighting on those, and as that ramps up, we'll definitely benefit from that. We're a little cautious in our forecasting, but that is an area that we do expect to see upside from at some point. I'm not going to predict exactly when, but it's certainly in our planning.

Okay. Well, yeah, thanks for the call this morning. I'll go ahead and leave it there.

Thanks, Luke.

And it appears we have no further questions at this time. I would now like to turn it back over to management. Go ahead, Don Duda. The floor is back to you.

All right. Kat, thank you very much. And we'll thank everybody for listening today and wish everyone a very pleasant and safe Labor Day holiday. Good day.

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