Methode Electronics, Inc.

Good morning, ladies and gentlemen, and welcome to the Method Electronics second quarter fiscal 2022 results. At this time, all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Robert Cherry, Vice President of Investor Relations of Method Electronics. Sir, the floor is yours.

Thank you, Operator. Good morning, and welcome to Method Electronics fiscal 2022 second quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2022 Second 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 law. Method undertakes no duty to update any forward-looking statements 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 Method'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 2022 second quarter earnings conference call. I'm joined today by Ron Zumis, our Chief Financial Officer. Both Ron and I will have opening comments, and then we will take your questions. Let's begin with the highlights on slide four. Our sales for the quarter were 296 million. We had a significant headwind in our automotive segment due to the ongoing supply chain disruptions, particularly the semiconductor shortage. That shortage led to auto OEM production slowdowns and, in some cases, production shutdowns. This, in turn, led directly to lower sales in our automotive segment, especially in North America. Helping to offset that auto headwind were near record sales in our industrial segment, There was strength in sales across all our industrial product categories, but in particular, we saw growth in electric vehicle bus bars, commercial vehicle lighting, and radio remote controls. Respectively, these products are benefiting from the macro growth trends of electrification, e-commerce, and automation. The industrial sales in our portfolio relative to our automotive sales continue to grow. As I mentioned, our team continued to face supply chain challenges. These include the ongoing semiconductor chip shortage, pandemic-related supply chain disruptions, and port congestion, all of which are increasing costs and consequently negatively impacting margins. Our team has worked diligently to mitigate these challenges, which in many cases require remedial actions such as expedited shipping and premium component pricing. In addition, we are working relentlessly with our customers to share in the absorption of these costs. The timing of these cost recoveries is not certain. At this point, our expectation is that these conditions will last until the end of our fiscal year. This extended period of demand recovery and margin pressure is the driver of our revised guidance for the full fiscal year. The situation is fluid, and our mitigation efforts are ongoing, but we are confident that we will continue to execute and meet our customers' requirements. Ron will provide more detail on our guidance later in the call. On the new order front, we were encouraged by the diversity of awards across key applications. In addition to our traditional automotive market, we secured awards in cloud computing, commercial vehicle, and EV applications. Focusing on EV, last quarter we reported that sales into EV applications were 16% of the consolidated sales. This quarter, EV sales were, again, 16% of consolidated sales. However, on a dollar basis, they were higher and, in fact, were a record for methode. Our expectation for that percentage for the full year continues to be in the mid-teens. Our EV activity is being fueled by growth in our power distribution offerings, where we leverage over 40 years of expertise to supply power products to various EV OEMs. In the quarter, we further reduced debt generated positive operating cash flow, and continued to return capital to shareholders. Our free cash flow was positive, even though we invested in inventory to support our deliveries to customers and to help mitigate supply chain disruptions. While our debt was down, we did have an increase in net debt as we utilized a portion of our available cash to execute a $35 million share buyback in the quarter. We have now executed half of the $100 million stock buyback authorization since it was announced last March. Before I provide detail on our business awards, I want to provide some information on an existing program. I can now share with you a little more detail on our largest truck center council program. We expect a small portion of the sales from this program to start to roll off late this fiscal year, which was included in our original full-year guidance. Then in fiscal 2023, We expect the bulk of the remaining truck program sales to roll off in the range of $90 to $100 million. The fiscal 2024 impact is negligible. 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 this truck program. Moving to slide five, Methode had another solid quarter of business awards. These awards continue to capitalize on key market trends like cloud computing and vehicle electrification. The awards identified here represent some of the key business wins in the quarter and represent $25 million in annual sales at full production. In non-EV automotive, we're awarded programs for lighting and user interface applications. In cloud computing, we saw demand for our power distribution products and data center applications. In commercial vehicles, were signs of an upcycled continue, we were awarded programs for exterior lighting solutions. In EV, we won awards for switch, lighting, and power distribution programs. Overall, our business awards are delivering on our strategic priority to drive customer, product, and geographic diversity. To conclude, despite the ongoing demand fluctuations and supply chain challenges, we are still in a position to deliver solid organic growth sales for fiscal 2022 while generating positive free cash flow. At this point, I'll turn the call over to Ron, who will provide more detail on second quarter financial results. Ron.

Thank you, Don, and good morning, everyone. Please turn to slide seven. Second quarter net sales were 295.5 million in fiscal year 22, compared to 300.8 million in fiscal year 21, a decrease of 5.3 million or 1.8%. The year-over-year quarterly comparisons included a favorable foreign currency impact on sales of 2.8 million in the current quarter. Sequentially, sales increased by 7.7 million, or 2.7%, from the first quarter of fiscal year 22. The decrease in second quarter sales was mainly due to lower automotive sales, especially in North America, as compared to the same period in fiscal 21, which benefited from the rebound from the depths of the impact of COVID-19 pandemic experienced in our first quarter of fiscal year 21. The sales decrease was partially offset by higher sales of electric hybrid vehicle products, which amounted to 16% of sales in the second quarter of fiscal 22, which was in line with our previous communication that electric and hybrid vehicles sales would comprise a mid-teens percentage of our fiscal year 22 consolidated sales. In addition, stronger commercial vehicle sales contributed to the robust industrial segment sales growth. Second quarter net income decreased 11.1 million to 27.5 million or 72 cents per diluted share from 38.6 million or $1.01 per diluted share in the same period last year. Net income was negatively impacted from decreased sales, the impact of higher materials and logistics costs and other operating costs and inefficiencies due to the global supply chain shortages and logistics challenges, higher stock-based compensation costs, and lower other income, partially offset by lower restructuring costs and favorable foreign currency translation. Please turn to slide eight. Second quarter gross margins were lower in fiscal year 22 as compared to fiscal year 21, mainly due to higher material and logistics costs, including freight and supply chain shortages and unfavorable product mix. Fiscal year 22 second quarter margins were 23.4% as compared to 26.9% in the second quarter of fiscal year 21. The negative impact of supply chain disruption and higher logistics costs including freight, on the second quarter fiscal year 22 gross margin was approximately 250 basis points. Unfavorable product mix also impacted gross margins. These higher costs that were experienced in the second quarter are expected to continue further into fiscal year 22. In addition, we anticipate a degree of cost inflation in the remainder of the current fiscal year. Fiscal year 22 second quarter selling and administrative expenses as a percentage of sales increased to 10.6% compared to 10.2% in the fiscal year 21 second quarter. The minor fiscal year 22 second quarter percentage increase was attributed to higher stock-based compensation partially offset by lower professional fees and restructuring costs. the second quarter fiscal year 22 selling and administrative expenses percentage is in line with our historical norm, which should yield an efficient flow-through from gross margin to operating income. Please turn to slide nine. In addition to the gross margin and selling and administrative items mentioned above, one other non-operational item significantly impacted net income in the second quarter of fiscal year 22 as compared to the comparable quarter last fiscal year. Other income net was down by $1.7 million, mainly due to lower international government assistance between the comparable quarters and increased foreign exchange losses from remeasurement. The effective tax rate in the second quarter of fiscal year 22 was 16.7%, as compared to 16.5% in the second quarter of fiscal year 21. The fiscal year 22 full-year estimate, which does not include any discrete items, is estimated to be between 17% and 18%, tightening the high end of the range down from 19% to 18%. Shifting to EBITDA, a non-GAAP financial measure, fiscal year 22 second quarter EBITDA was $47.4 million versus $60.2 million in the same period last fiscal year. EBITDA was negatively impacted by lower operating income and lower other income. Please turn to slide 10. In the second quarter of fiscal year 22, we reduced gross debt by $12.3 million, and we ended the second quarter with $177.2 million in cash. During the first six months of fiscal year 22, net debt, a non-GAAP financial measure, increased by $39 million, mainly due to the share repurchases of $42.4 million and unfavorable working capital changes, especially related to inventory, which increased by nearly 26 million due to the supply chain related challenges. Regarding capital allocation on March 31st, we announced the 100 million share repurchase program, which we executed nearly 35 million of purchases during the second quarter of fiscal year 22. Since the authorization's approval, we purchased nearly 50 million worth of shares at an average price of $44.04. 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 the fiscal year 22 second quarter, free cash flow was $21.6 million compared to $36.7 million in the second quarter of fiscal year 21. The decrease was mainly due to negative working capital changes, especially from the inventory items we discussed prior. We experienced sequentially improved free cash flow in the second quarter of fiscal 22 as compared to the first quarter of fiscal 22. We anticipate our proven history of generating reliable cash flows, which allows for ample funding of future organic growth, inorganic growth, and continued return of capital to the shareholders. In the second quarter of fiscal year 22, we invested approximately $5.4 million in CapEx as compared to $3.8 $6 million in the second quarter of fiscal year 21. The higher CapEx is in line with our expectation that CapEx in fiscal year 22 would be higher than the investment in the prior fiscal year. We now estimate fiscal year 22 CapEx to be in the $45 to $50 million range, which is lower than the prior estimates for the current fiscal year of $50 to $55 million we provided earlier. The decrease is simply the result of the timing of the cash outflows of approved projects as opposed to a concerted effort to slow or reduce the gains of capital investment. Investing for future organic growth and vertical integration remains a key priority from a capital allocation strategy perspective. We do have a strong balance sheet, and we'll continue to utilize it by continuing investment in our business to grow them organically. we continue to pursue opportunities for inorganic growth and a measured return of capital to the shareholders. Please turn to slide 12. Regarding guidance, it is based on management's best estimates. External events and their related potential impact on our financial results remain an ongoing challenge. As Don mentioned in his remarks, we lowered our previously issued revenue and earnings per share guidance largely due to the persistent headwinds from the ongoing negative impact of the chip shortage and logistics challenges. As you recall in our September conference call, we noted that the persistent headwinds could call our performance to be below the midpoint of the ranges of our original guidance as the situation was fluid and would likely remain challenging. These headwinds continue to adversely impact our second quarter results and will likely be with us for the remaining six months of our fiscal year. The revenue range for full fiscal year 22 is between $1.14 and $1.16 billion, down from a range of $1.175 to $1.235 billion. Diluted earnings per share range is now between $3 per share and $3.20 per share, down from $3.35 to $3.75 per share. The range is due from the uncertainty from the supply chain disruption for semiconductors and other materials on both Messload and its customers. From a sales perspective, lower sales could result from a supply disruptions to us 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, other logistic factors such as port congestion. Higher costs for materials, freight, and labor are a constant and dynamic battle, and we remain uncertain as to when things will stabilize. Don, that concludes my comments.

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

Certainly. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star 1 on your phone at this time. We do ask that while posing your question, please pick up your handset if you're listening on speakerphone to provide optimum sound quality. Once again, if you have any questions or comments, please press star 1 on your phone. Please hold while we poll for questions. Your first question is coming from Luke Junk from Baird. Your line is live. Thanks for taking the question. Good morning.

Good morning. So first question I want to ask is on guidance. So I know you're not giving third quarter guidance, just wondering at a very high level if there's any factors that you could discuss that we should be thinking about from a modeling perspective, 3Q versus 4Q in your fiscal year, especially the interest in your perspective on underlying auto and commercial vehicle trends and also Just want to make sure there's nothing that's sort of one-off in nature that we should be aware of. I know Ryan, you mentioned the FX remeasurement in the current quarter, for example. Just want to make sure there's nothing that we should be looking for in the back half of the year that could be impactful like that.

I think the main thing that'll affect the cadence of the second half is, you know, we're going into holiday production shutdowns that always has an impact both in the U.S. and in and in Europe, so the Q3 tends to be a lesser revenue quarter historically. So I think that would be the biggest factor. And the balance is really unknown on supply chain disruptions. I will comment that to some degree, maybe we've reached in the U.S. a bottom of that, and that's a, I guess a qualified maybe. And then in Europe, we've seen more disruptions in the previous quarter than we've had in the past. So one may be getting slightly better and the other one might be getting a little bit worse. Ron, is there anything?

Yeah, no, clearly, I mean, historically, our third quarter, due to, as Don mentioned, the holiday shutdowns and simply less shipping days, tends to be our weaker quarter and our fourth quarter tends to be stronger and

we would expect that you know but to follow to follow suit that type of cadence okay great thank you for that second question would be in terms of the state of your supply chain obviously a number of comments in the prepared remarks on that i'm hoping we can maybe discuss sequentially what you saw in the second quarter versus the uh the first quarter of the year sort of where you exited uh the previous fiscal year especially wondering where you're seeing incremental challenges right now from a supply chain and material standpoint, and as we zoom out and look at what this might look like going forward, how much permanence do you see in costs that are in the P&L right now versus things that might be, say, less permanent in nature or subject to potential customer recoveries, let's say?

Let me answer that one first. As I said in my remarks, we are diligently working with customers to mitigate the entire supply chain issues from a cost standpoint. That takes some time. We think that's going to be with us for the duration of the fiscal year. The success on that is contemplated in the high and low end of our guidance. COVID is still part of the supply chain issues that in certain areas has subsided, in other areas it's still contributing to labor shortages and causing our inventory to be higher than it needs to be. We will work down the inventory as the disruptions subside. Exactly when is very difficult to say. From a cadence standpoint, from Q2, or Q1 to Q2, It was 250 basis points. Did things get worse? They did not get better. I think that's the best I can say about that. Are we getting maybe a little more confident in our ability to deal with the shortages? Maybe from a labor standpoint, port congestion, yes. But again, I see that continuing. through the end of the fiscal year. And every day is really a new challenge. Normally in auto, the production schedules are pretty well cast at the end of a quarter. And for this whole year, it's been changing on a daily basis. Ron, is there anything?

Yeah, I would just say that, you know, as time goes on, I mean, this is... From a basis point perspective, we did a little better than we did in the first quarter. But as time goes on, we'll be better positioned to eventually get better or get more accommodating in terms of cost sharing and things of that nature. So one quarter doesn't make a trend, but certainly we can be in a position to maybe do better with that down the road. And that's contemplated in our guidance.

Okay, thank you for that. Next thing I want to ask about, I appreciate the disclosure in terms of the existing large truck center council program and was just hoping to understand, you know, the revenue numbers that you provided are really helpful. Just hoping to understand the margin puts and takes related to that. I know there's certainly going to be a gross margin impact in terms of mixes that business rolls off and, you know, certainly there's a manufacturing overhead impact as well. Where do those two lines intersect? And, you know, I don't want to get into fiscal 23 guidance per se, but just, you know, any high-level considerations as you think about the margin progression would be helpful.

Sure. That's been a very good program for us. But it, and I think we've said this in the past, it's not the highest margin program and it is being replaced. by higher margin EV program. So we would expect, without getting into the exact timing of it, we would expect that our margins, as that rolls off and other programs roll on, that our margins would improve. In terms of overhead and the associated costs of that, we're pretty good at looking at programs How are we rolling off? How do we adjust the factory overhead accordingly? What are we bringing in? We look at floor space. We look at indirects. Of course, we look at labor, and those are all being put in place now as we start to see the roll-off of that program. Inventory is another area that we look at. You don't really want to have a whole lot of inventory left as the program goes end of life, but there's also a service that we have to provide for three to five years at a minimum, so we'll take that into account. I would say that we're on top of that. We've had other programs roll off and other ones roll on, and you adjust your factory accordingly.

Okay, and then if I could just ask a last question, a little bigger picture noticed on the business awards that one of the words that was interesting this quarter is bus bars for charging and just hoping you can expand on what that opportunity set might look like for methode going forward sure that that is for commercial vehicle charging not the charge stations that you might see in a parking garage and that's that's

I don't know if there's any more to say on that. It's a bus bar. It deals with the commercial vehicles. In other words, at a FedEx, I'm not saying it's FedEx, but at a depot, those charges would be charging the vehicles overnight, and we're providing the bus bars for that.

Got it. Okay, well, that's all I had for this morning, so thank you again for taking the questions. Luke, thank you very much.

Thank you. Once again, ladies and gentlemen, if you have any questions or comments, please press star 1 on your phone at this time. Your next question is coming from Matt Sheeran from Stiefel. Your line is live.

Yes, thanks, and good morning, everyone. I just had a quick follow-up question regarding your comments on the cost headwinds. and your ability or inability to pass them along to your auto customers. Some of your peers selling into auto appear to have more success. So I'm wondering, are you sort of locked into contracts that make it difficult? How are those conversations with customers going?

I would say as well as can be expected in terms of we're asking for price increases and logistics relief. That does take time and we've been there before and we're confident that we will recover our margin. Maybe some of our competitors are ahead of the game. We track it on a on a weekly basis. We know what conversations are taking place. The answer is not we won't get increases. This is really a matter of timing. And the other thing to point out is some tiers have material riders, and so the price increases are automatic. We don't have those. In our typical automotive contract, we do have that in some of our non-EV or power distribution contracts where we have material adders. So some of that could be automatic. In our case, it's not. Our programs tend to be four to five years. They are contractual. And it's unusual times, and that takes some discussions. And I think I would also point out that actually auto has been I don't know if accommodating is the word, a little bit easier to have those discussions than actually with our commercial vehicle. I think this is the first quarter I can say we've made some progress. That's been a little tougher going than auto. I'm not saying that auto is easy. We've had some very tough discussions whenever you're asking for a price increase.

I was just going to mention on the CV space.

Okay. Thanks very much for that. And just regarding the strength you're seeing on the EV side, it seems like you've got some good content gains. Are you also winning new programs and new logos in terms of customers?

Yes. And I think it's important to point out that it's Some of it is some of the startups and also the traditional OEMs as well. So we've been very pleased with the bookings we've had there, and that supports our growth going forward. Okay, great. Thanks very much. Thank you.

Thank you. As a final reminder, press star 1 at this time for any questions. Please hold while they poll for questions. Thank you. There are no further questions in the queue. I'll now hand the conference back to Donald Duda, CEO, for closing remarks. Please go ahead.

Thank you very much. We'll thank everyone for listening today and for the questions, and we'll wish everyone a very safe and pleasant holiday season. Good day.

Thank you, ladies and gentlemen. This concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.

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