Methode Electronics, Inc.

Good morning, ladies and gentlemen, and welcome to Method Electronics Q3 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, Rob Terry, 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 Third Quarter Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2022 Third 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 reflects 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 Method's filings with the Securities and Exchange Commission, such as our 10 and 10 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 2022 third 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 $292 million. Helping ourselves by 9 million were successful premium freight cost recovery efforts. However, our automotive segment encountered demand headwinds in Europe due to the ongoing supply chain disruptions, particularly the semiconductor shortage, leading to various European auto OEM production slowdowns. In our industrial segment, we saw strength across all our product categories, but particularly in power and lighting products. In particular, the segment saw growth in electric vehicle bus bars, commercial vehicle lighting, and radio remote controls. These products continue to benefit from the macro growth trends in electrification, e-commerce, and automation. As such, our industrial sales again outgrew our automotive sales, a trend we expect to continue. As I mentioned, our team continued to face the ongoing supply chain challenges in the quarter. They have worked diligently to mitigate these challenges, which required remedial actions such as expedited shipping and premium component pricing. We have worked relentlessly with our customers to share in the absorption of these increased costs, particularly with the premium freight. In addition, we've taken the proactive step to consolidate an operation into another existing facility in response to these logistical challenges. We are confident that this action will help reduce some supply chain risk, improve customer service, and ultimately drive margin expansion. Ron will provide more details on this restructuring later in the call. On the order front, we had a very strong quarter with over $100 million in new program awards. Of these new awards, approximately 70% were for EV applications, and of the EV awards, a large majority were for power distribution products. I will provide more color on our new awards in a moment. Focusing on EV, last quarter we reported that sales into EV applications were 16 percent of consolidated sales. This quarter, EV sales were groomed to 19 percent of consolidated sales, a record for Method. Given our year-to-date performance with EV sales, we now expect that percentage will be in the high teens for the full fiscal year, up from our previous mid-teens guidance. Our EV activity continues to be fueled by growth in power distribution, where we leveraged over 40 years of expertise to supply power products to various EV OEMs. In the quarter, we further reduced debt and continued to return capital to our shareholders. While our debt was down to the lowest level since the Greycon acquisition, We did have an increase in net debt as we utilized a portion of our available cash to execute a $21 million share buyback in the quarter. We have now executed over $70 million of the $100 million stock buyback authorization since it was announced last March. Moving to slide five, Methode had a very strong quarter of business awards. The awards identified here represent some of the key business wins in the quarter, and represent over $100 million in annual sales at full production. As a reminder, the full launch timing of some of these programs could be anywhere in the range of one to three years from now. As you can see, the list is dominated by EV programs representing three-quarters of the dollar value. And within those EV awards, power products were the main focus with several bus bar programs and a battery disconnect unit program. One of those bus bar programs was a significant first win for Method with a large, established German automotive OEM. These EV awards, which are part of the skateboard of the electric vehicle, are expected to have a longer program life than traditional ICE programs, as the OEM will leverage their investment over multiple EV platforms and model or top hat refreshments. In non-EV automotive, we were awarded programs for several user interface applications, including HVAC switch bars, overhead councils, and parking brake switches. We also won awards for a motorsport headlamp and a micro-DPU for a telecommunications company. Overall, it was a very successful quarter for new programs that will drive organic growth in future years. To conclude, it was a well-executed quarter by a worldwide worldwide team, and despite some ongoing demand headwinds and supply chain challenges, we are still expecting to deliver strong organic growth for fiscal 2022. Looking beyond this fiscal year, our award pipeline continues to be strong, as evidenced by this past quarter, and puts Method on a path to deliver long-term results. At this point, I'll turn the call over to Ron, who will provide more detail on our third quarter financials.

Ron? Thank you, Don, and good morning, everyone. Please turn to slide seven. Third quarter net sales were 291.6 million in fiscal year 22 as compared to 295.3 million in fiscal year 21, a decrease of 3.7 million, or 1.3 percent. The year-over-year comparison includes 8.6 million of premium freight cost recovery partially offset by an unfavorable currency exchange impact on sales of $2 million. Excluding the premium freight cost recovery and the foreign currency impact, sales decreased by 10 million, or 3.5%. The decrease in third quarter sales was mainly due to the lower automotive sales in Europe. This sales decrease was partially offset by higher sales of electric and hybrid vehicle products, which amounted to 19% of sales in the quarter, which is higher than our previous communication that electric and hybrid electric vehicle sales would comprise a mid-teens percentage of our fiscal year 22 consolidated sales. We now expect electric and hybrid electric vehicle sales to represent the high teens of our full year fiscal 22 consolidated sales. In addition, stronger commercial vehicle and power product sales contributed to the industrial segment growth. Income from operations decreased by $5.6 million mainly due to marginally lower gross margins and marginally higher selling and administrative expenses. Third quarter net income decreased $2.5 million to $29.4 million or $0.78 per diluted share from $31.9 million or $0.83 per diluted share in the same period last year. Please turn to slide eight. Third quarter gross margins were lower in fiscal 22 as compared to fiscal year 21 due to lower sales volume, unfavorable product mix, higher restructuring costs, partially offset by premium freight cost recovery. Fiscal year 22 third quarter margins were 23.7 percent as compared to 24.6 percent in the third quarter of fiscal year 21. In addition, we do anticipate a degree of cost inflation in the remainder of this current fiscal year and into our fiscal year 23. Fiscal year 22 third quarter selling and administrative expenses as a percentage of sales increased to 11.8 percent as compared to 11 percent in the fiscal year 21 third quarter. The minor fiscal year 22 third quarter percentage increase was mainly attributable to restructuring costs. This quarter, selling 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 nine. Net income was negatively impacted from the decreased sales, higher restructuring costs, unfavorable product mix, and higher selling and administrative expenses, partially offset by premium freight cost recovery, higher other income, and lower tax expense. In addition to the gross margin in selling and administrative items previously mentioned, one other non-operational item significantly impacted net income in the third quarter of fiscal year 22. As mentioned, other net income was up by $2 million, mainly due to success in securing higher amounts of international government assistance between the comparable quarters and lower foreign exchange losses from remeasurements. The effective tax rate in the third quarter of fiscal year 22 was 12.2 percent as compared to 12.6 percent in the third quarter of fiscal year 21. The fiscal year 22 full year estimate of between 16 and 17 percent includes the impact of the 2.2 million of discrete items recorded in the third quarter and is lower than the previous range of 17 percent to 18 percent. Shifting to EBITDA, a non-GAAP financial measure, Fiscal year 22 third quarter EBITDA was $47.9 million versus $51.3 million in the same period last year. EBITDA was negatively impacted by lower operating income mainly due to increased restructuring costs and unfavorable product mix, partially offset by premium freight cost recoveries and higher other income. Please turn to slide 10. In the third quarter of fiscal year 22, we reduced gross debt by 7.5 million and ended the quarter with 153.1 million in cash. During the first nine months of fiscal year 22, net debt, a non-GAAP financial measure, increased by 55.6 million, mainly due to the share purchases of 63.9 million and unfavorable working capital changes, especially related to inventory, which increased by nearly 45 million due to the supply chain-related challenges. Regarding capital allocation, on March 31st, 2021, we announced a $100 million share repurchase program, which we have executed 21.3 million of purchases during the third quarter of fiscal year 22. Since the authorization's approval, we have purchased 71.2 million worth of shares at an average price of $44.72. 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 third quarter, free cash flow was 11.8 million as compared to 82.2 million in the third quarter of fiscal year 21. The decrease was mainly due to negative working capital changes, especially from inventory, resulting from difficult logistics and accounts receivable, which had a significantly favorable impact in the third quarter of fiscal year 21 as compared to the third quarter of fiscal year 22. In addition, CapEx was $8.3 million in the current quarter as compared to $4.9 million in the third quarter of fiscal year 21. We do anticipate continuing a 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. 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 estimate fiscal year 22 CapEx now to be in the 35 to 45 million range, which is lower than our prior guidance of 45 to 50 million. The decrease is simply the result of timing of cash outflows of approved projects as opposed to any concerted effort to slow or reduce the cadence of our capital investment. Investing for future organic growth and vertical integration remains a key priority from a capital allocation strategy perspective. We have a strong balance sheet, and we'll utilize it by continuing investments in our businesses to grow them organically. In addition, we assertively continue to pursue opportunities for inorganic growth and measured return of capital to shareholders. Please turn to slide 12. Regarding guidance, it is based on management's best estimate. External events such as the headwinds from the ongoing negative impact from the chip shortage, logistic challenges, and other related items can impact potentially our future results, and these headwinds remain an ongoing challenge. While we have experienced increased success in recouping some incurred costs, we expect these headwinds will likely be with us, for the remaining three months of the current fiscal year. We increased our previously issued annual revenue guidance mainly due to the revenue from cost recoveries, which are non-product sales. The revenue range for full fiscal year 22 is now between 1.16 and 1.17 billion, up from a range of 1.14 to 1.16 billion largely due to the previously mentioned premium for cost recoveries, which amounted to $8.6 million in the third quarter. The diluted earnings per share range has been tightened to $3.05 to $3.15 from the prior range of $3 to $3.20. The midpoint of our APS guidance remains unchanged. Higher costs for material freight and labor are a constant and dynamic battle and we remain certain as to when things will fully stabilize. Don, that concludes my comments.

Ron, thank you very much. Matt, we're 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 you poll for questions. Your first question is coming from Chris Howe from Barrington Research. Your line is live.

Good morning, everyone.

Good morning.

Starting first off, two questions here. With the new business wins, you mentioned approximately 70% of the applications going to the EV market. can you talk about these new business wins in a little bit greater detail as far as how you anticipate the potential or maturation of these new business wins as we move further out into the future over the next several years? I would imagine that we're just at the kind of initial stages of this and the potential for additional EV application wins should only increase from here.

Yes, I would agree with that. As I said, the EV awards, they'll get the full launch as short as 12, 16 months from now. The major ones are at least 24 months out to maybe even 30 months until you get the full launch. just because it launches doesn't mean you're running at the full rate. And they run the usual launch cycle of our ICE Awards. Really nothing unusual there. And you're right, the potential, as you launch these programs, you'll see that carried over onto other platforms. So maybe a $20 million annual win might turn into 30, 35 as you go through the launch. So we do anticipate some of that occurring. A little more color. A lot of those are on the skateboard, which is exciting for us. It's hard to predict the length of the programs. The contracts are four or five years, some even longer. But we're all in unchartered territory on how long the awards will go. Will they be like a transmission program where, gee, our lead frame program is 10 years plus? I think we can anticipate that. So we like the Skateboard Awards because there's not as much refresh that's going on there. And I would also say the majority of the awards, particularly the larger ones, are with established OEMs, which are also I also like to see there's more confidence in the volumes rather than nothing against the startups we deal with, but it's a little easier to predict revenues with an established automaker.

That's perfect. Very helpful. And next, about the semiconductor situation, semis. We're still undergoing this situation. I think you hinted at it. It's going to go into fiscal year 23. As we think about that challenge and perhaps also the challenges you're seeing in Europe on a directional basis, how do you think that plays out in the first half of fiscal 23 and the second half of fiscal 23 when we kind of look at that versus how this past year is playing out?

You take the approach that it takes about two years to add capacity, and I might be a little light on the two years. We're about a year into it, maybe a little longer, depending on what was happening before the shortage in terms of capacity addition by the suppliers. So maybe a conservative way of looking at it is that the duration of this calendar year, I think that's going to be an issue. Now, it may, some people have predicted that it'll start to get better in the second half, but we're kind of looking at it that this is a, until capacity has been added sufficiently, this is going to be with us. And that's really how we, that's how we look at guidance, and that's really how we will look at our fiscal of 23 as well.

Yeah, no, I would say that it's still, a lot of uncertainty, not only to us in securing components so we can ship to our customers, but the OEMs that we serve, we're still dependent on how well they have navigated the search. So we expect that to continue. You know, one thing we have done a better job and we spiked it out in success is, you know, recovering costs and getting into more of a cost sharing arrangement than we did in the first and second quarter of the year. So we're certainly navigating the negative impact of that as best we can. But still, obviously, a lot of uncertainty on how it's going to impact our customers ultimately and the demand for our product.

Okay. Yeah, a lot of industrial companies are going with the second half thesis, but in my opinion, that just means it's not going to be like the first half. We'll see how the second half plays out. But as I follow up on some of your comments there. Q4, typically your strongest quarter. We know Q3 is typically weaker. Any puts and takes there that you can see at this point with how that plays out in fiscal year 23 or too early to tell and the typical seasonality of the business should run its course?

I agree that generally our fourth quarters are strongest, but as all of us mentioned here, the supply chain issues can impact that. And as far as we look forward, I think we're like everybody else. There's so much uncertainty, it's hard to... We can look at on paper and say, organically, we're looking good, but you really have to see what... what starts to happen on the second half of the year. Auto can be very tough, but one thing that generally it's fairly predictable, but in the past two years it's running against that theory. So it's very hard to say what June or July is going to bring. I'd like to answer that, but it's just like anyone else, we don't know.

All right. Well, Thanks for taking my question. I'll hop back in the queue to give others a chance. Thanks.

Thank you. Your next question is coming from John Frangereb from Sedoti and Company. Your line is live.

Good morning, everyone, and thanks for taking the questions. Good morning. I'd like to start with the industrial business. It had a good quarter on a year-over-year basis and was up sequentially despite the seasonality of having the days off in the third quarter. What does January and February tell you about the recovery in the Class A truck market and how it's kind of looking for the balance of calendar 2022?

The way we look at the commercial vehicles, that's a definite tailwind for us as we go into 2021. The second half of the year, the sales have been good. Last mile vehicles, I think ACT has the numbers up. So we're very positive on that. That certainly helped the third quarter, no question about that. Now, to what degree, as I said to Chris, to what degree that's negatively affected by shortages and so on, we'll have to see. But in general, we see that as a bright spot to have looking forward.

Ron? No, no. We follow the ACT, and everything's looking pretty good. And unless something happens, we would expect the fourth quarter to improve.

And one of the things that we talked about restructuring, we did a logistics move. out of Seattle and the poor congestion there and consolidated in our Mexican logistics center. So that'll take a while to sort through, but we did that to, one, to certainly reduce inventory and some of the volatility and be able to service our customers better than that. We took that step in the quarter. And I would imagine to go through the system It'll be the first quarter of fiscal year before we see the results of that.

Got it. Got it. And just a little clarity on the free recovery costs. It seems like in the press release, it's a zero impact to profitability there. But then when I was perusing the queue, it seemed like it did have an impact on the gross margin profile. Please help me understand how this mechanism is working so I can get a better grasp of the whole concept here.

Sure. We're in a position now as compared to before where before we do any premium freight, we either contract up to cost share or we're getting the improvement from previously incurred costs, and that was what that $2.8 million was, was a recovery for costs in the third quarter that occurred in the first and second quarter when we were significantly negatively impacted by that. So we're going to continue to get straight up, before we do things, agree to cost sharing so we don't have that negative impact, and we're going to continue to try to recover any previously premium freight or any other cost for that matter. We're going to continue to do so. And the cadence of that success could happen in this quarter. It could happen in the first quarter of next year. But those are the mechanisms that we did. But we just felt it was pretty important to spike that out as, quote, non-product sales and that we are starting to see some significant success. You know, in the first two quarters, one was 240 basis points, you know, 7 to 8 million in each of the first two quarters, and in this quarter, it was negligible, right? So we've made an impact, and that's how we should be, you know, kind of thinking about that on a go-forward basis.

Got it. That was helpful. And I guess one last question. On the other income line, Are there two items there or is there one? Is there a 2.2 and a $1.1 million? One's a grant and one's a COVID recovery number. What were those numbers and how should I think about actually that line going forward?

Yeah, so, you know, the other income line consists of any government assistance, whether it's COVID related or whether it's related to some other opportunity that we have to secure funds. And the other one is the foreign exchange from remeasurement and all of our financial assets and accounts, payable accounts, all those financial assets. So those are the two main parts. But we keep all government assistance in that other income line.

Are you still receiving government assistance into the fourth quarter? Is that part of your guidance?

So in the fourth quarter, we continue to... Try to secure all the – that's always an ongoing thing for the company, and any success in that has been contemplated in our guidance.

Got it. All right. Thanks for taking my question.

Go ahead.

Right. COVID, yeah. Yep. Okay. All right. I'll get back into queue, guys. Thanks for taking the questions. Thank you.

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 Nick Steven from Baird. Your line is live.

Hey, everyone. Thanks for taking my questions. So my first one is, insofar that your updated 2022 guidance is also de facto 4Q guidance, And considering we're already a month into the quarter, could you just walk us through the puts and takes assumed at the high and low ends of the guidance range, respectively, and what do you see as the main swing factors for your fiscal 4Q?

So, rightfully so, it is de facto 4Q guidance. And, you know, some of the puts and takes are the recovery, the cadence, and the amount of recovery in European auto as compared to the 16 million decrease we had in the third quarter. That's from a product standpoint, that would be that. And having a bit of, you know, recovery in some of our sensor products and things of that nature. So the cadence and the amount of that would, you know, we narrow the range to the 10 million, right? So those are the main puts and takes that we contemplated from a, product standpoint in getting to that tightened uprange.

Yeah, and we can say that sensors were somewhat affected in the third quarter, not by shortages on our part, but on our major customer's part, and it was magnesium, which we're anticipating that we'll see some recovery in the fourth quarter and probably in our first quarter or It wasn't a lack of demand. It was a supply issue.

Perfect. That's super helpful. And that leads into my last question on sensors. In a little bit bigger picture, but could you guys provide any update on kind of key sensor-related opportunities for Methode, and how has that business performed this year versus your expectations? Thanks.

From expectations, it's at or slightly above It was, and then the third quarter was down a bit because we aforementioned shortages. So we'll see where we end the year, but that's a definite bright spot for us. The main use is in e-bikes. E-bikes continue to be very popular in Europe, and they are definitely, if you're part of the fund, gaining momentum in the United States as well. So going forward, we see that as a bright spot for us. for us in e-bikes, and we continue to look for other applications. There's a medical application perhaps in electric wheelchairs that are lithium-powered that won't be as probably large market as we would see with e-bikes, but we continue to look for applications for the sensors.

Perfect. Thanks. Thank you. That concludes our Q&A session. I will now hand the conference back to Donald Duda, President and CEO of Method Electronics, for closing remarks. Please go ahead.

Matt, thank you very much, and we'll thank everyone for listening and have an enjoyable upcoming weekend. Thank you.