Methode Electronics, Inc.

Good morning, ladies and gentlemen, and welcome to the Methode Electronics first quarter fiscal 2023 results call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for 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. Sir, the floor is yours.

Thank you, Operator. Good morning. And welcome to Metho Electronics Fiscal 2023 First Quarter Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2023 First Quarter Financial Results, which can be viewed on the webcast of this call or found at 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 METSO's filings with the Securities and Exchange Commission, such as our 10-K and 10-Q reports. At this time, I'd like to turn the call over to Mr. Don Duda, President and Chief Executive Officer.

Thank you, Rob, and good morning, everyone. Thank you for joining us for our fiscal 2023 first quarter earnings conference call. I'm joined today by Ron Zumis, our Chief Financial Officer, Both Ron and I will have opening comments and then we'll take your questions. Let's begin with the highlights on slide four. Our sales for the quarter were $282 million. Helping our sales by $11 million were successful spot buy and premium freight cost recovery efforts. Working in the opposite direction was foreign currency, which had a negative $14 million impact on sales. Also working against us were market headwinds in our automotive segment, in Asia and Europe. In Asia, the COVID-19 lockdowns in China impacted the end of our fourth quarter as well as the beginning of our first quarter. In Europe, we saw continued weakness in the auto market due to macroeconomic conditions. Helping to offset the weaker auto sales was a record quarter of sales in our industrial segment. The surge in industrial sales was driven by power distribution both for data center and EV applications and by commercial vehicle lighting. This is in keeping with our strategic direction to grow our industrial segment. In the quarter, we continue to face the ongoing supply chain challenges. Our team is still working diligently to mitigate their impact, which requires remedial actions such as spot buys and expedited shipping. We have worked relentlessly with our customers to share in the absorption of these increased costs. These costs include inflation in materials, labor, and freight. Our ability to obtain reimbursement to offset these costs will lag as a matter of process as long as inflation continues. On the order front, we had another very strong quarter with over $90 million in program awards. As you will see later, these awards were in a variety of applications And once again, we're led by EV programs. Focusing on EV, like last quarter, EV sales were 17% of consolidated sales. This percentage, which was 19% two quarters ago, was again directly impacted by the COVID-19 lockdowns in China. With those lockdowns seemingly behind us and given the ongoing momentum in our EV activity, we still expect EV sales to reach a record 20 percent of our total sales in this fiscal year. In the quarter, we have positive free cash flow and purchased approximately $12 million of Metho stock. As of the end of the first quarter, we now have approximately $117 million of capacity in our buyback authorization, which expires in June 2024. Further, our debt is at its lowest level since the Greycon acquisition. Moving to slide five, Method had another very strong quarter of business awards. The awards identified here represent some of the key wins in the quarter and represent over $90 million in annual sales at full production. As a reminder, the full launch timing of most of these programs could be anywhere in the range of one to three years from now. Also, while most of the dollar value of these awards are for new programs, Some of these awards are for extensions or volume increases on existing programs. At the top of the list are EV programs representing over 40% of the total dollar value. The awards are mostly for power products and are from all of the additional big three U.S. automakers. The EV growth engine rolls on and our exposure to it continues to be robust. In non-EV automotive applications, We were awarded programs for all four of Method's core technologies, user interface, power, sensor, and lighting applications. Also notable is that they are in our two historically fastest growing regions, Europe and Asia. We also had solid awards for applications in motorsports, e-bikes, and millero. Here as well, we had good award diversity with lighting, sensor, and power products. Overall, It was a very successful quarter for awards that will drive organic sales growth in future years. To conclude, we continue to be cost challenged by inflation, which has yet to stabilize. However, our team is working every day to mitigate the impact, and we expect more progress as the year goes on. Looking forward, I am confident that Method is positioned to mitigate these pressures and deliver sales and earnings growth for fiscal 2023. This confidence has enabled us to confirm our sales and earnings guidance for the year. At this point, we'll turn the call over to Ron, who will provide more detail on our first quarter financial results and outlook for the full year.

Ron? Thank you, Don, and good morning, everyone. Please turn to slide seven. First quarter net sales were $282.4 million in fiscal year 23, compared to $287.8 million in fiscal year 22 A decrease of $5.4 million or 1.9%. Fiscal year 23 sales included $11.1 million of spot buy and premium freight cost recovery and unfavorable currency impact on sales of $14.2 million. Excluding the spot buy and premium freight cost recovery and the foreign currency impact, sales decreased by $2.3 million or 0.8%. Sales declined in the automotive segment, but increased in the industrial segment. The automotive segment saw a sales decrease of 19.2 million or 9.8%. Net sales were negatively impacted by foreign currency exchange of 8.9 million, but benefited from spot buy and freight recovery sales of 9.1 million. In North America, The 4.4 million decrease in the first quarter sales included the full impact from the roll-off of a major automotive program. In Asia, automotive segment sales decreased 9.1 million, or 23.4%, primarily due to China's COVID-19 zero-tolerance lockdown and the shutdown of a large customer's facility in July. We anticipate recovering a portion of the lost sales in the first quarter in our second quarter. In Europe, sales declined 5.7 million or 9.9%, largely due to foreign exchange headwinds of 7.7 million, partially offset by cost recoveries of 1.2 million. In addition to foreign exchange, sales were impacted by general economic uncertainty in the region. The weakness in the automotive segment was partially offset by record sales in our industrial segment, which experienced a sales increase of 13.6 million or 17.3%, resulting from strength in our commercial vehicle lighting and industrial non-EV power related product offerings. EV product applications amounted to 17% of sales in the quarter. This figure was adversely impacted from the lockdown and shutdown activity in China. Currently, we expect recovery in the next several quarters and still anticipate EV and hybrid electric vehicles to represent 20% of our full year fiscal 23 consolidated sales. First quarter income from operations in fiscal year 23 decreased to 21.8 million. from $34.1 million in fiscal year 22, mainly due to lower product sales, lower gross margins, mainly due to higher costs due to material cost inflation, spot buys, and other unreimbursed costs, the impact of overhead absorption due to a roll-off of a major automotive program, and modestly higher selling and administrative perspective. From a gross margin perspective, cost recovery actions did not keep pace with the accelerated inflation and other increased costs. It will take time to catch up on cost recovery, but actions are in process for recovery in future periods. These factors were partially offset by higher other income in the form of international government COVID-19 assistance, which increased from the $1.9 million in the first quarter of fiscal year 22 to 4.1 million in the first quarter of fiscal year 23. The other income spiked in the first quarter and we do not expect this elevated quarterly level of government assistance during the remainder three quarters of the fiscal year. First quarter net income in fiscal 23 decreased 7.6 million to 21.5 million or 58 cents per diluted share from 29.1 million or 76 cents per diluted share in the same period last year. Sequentially from the fourth quarter of fiscal year 22, diluted earnings per share increased 15 cents per share from 43 cents to 58 cents per diluted share. Please turn to slide eight. Fiscal year 23 first quarter gross margins were 21.9% as compared to 24.9% in the first quarter of fiscal year 22. A contributing factor in the decline in the consolidated gross margin profile was the increase in pass-through cost recovery sales at zero margin, which led to lower net product sales. When the MP of these sales is removed, fiscal year 23 first quarter consolidated gross margins would have been 22.8%. Automotive segment gross margins decreased 33% in the quarter of fiscal year 23, down from the 36.3% gross margins in the first quarter of 22, mainly due to decreased sales in North America and Asia. Industrial segment gross margins decreased to 33% in the first quarter, down from 36.3% gross margin in the first quarter of fiscal 22. Of the overall segment gross margin decrease, approximately 75% was due to material cost inflation increased freight and logistics costs, and 25% was related to inventory items such as unfavorable absorption due to China lockdowns and increased profit in ending inventory eliminations and other items. The 33% in industrial segment gross margins are more in line with the historical norms, and barring any substantial change in commercial vehicle or EV production levels, we anticipate opportunity for modest improvement in the industrial segment margin the remainder of the current fiscal year. Fiscal year 23 first quarter selling and administrative expenses as a percentage of sales was 12.5 percent as compared to 11.4 percent in the first quarter of fiscal year 22, mainly due to increased wages and other general administrative expenses and travel. Our selling and administrative expenses percentage of sales is reasonably consistent from a cost structure perspective and should yield an efficient flow through from gross margin to income from operations. Please turn to slide nine. Net income was negatively impacted from the operational items noted above, partially offset by higher income, lower tax expense, and lower net interest expense. The effective tax rate in fiscal first quarter of fiscal 23 was 17% as compared to 16.4% in the first quarter of fiscal year 22. The minor change in the effective tax rate was due to a mix of jurisdictional earnings. Shifting to EBITDA, a non-GAAP financial measure, fiscal year 23 first quarter EBITDA was $38.2 million versus $48.5 million in the same period last fiscal year. EBITDA WAS NEGATIVELY IMPACTED BY THE HIGHER COSTS DUE TO MATERIAL COSTS, INFLATION, SPOT BUYS, AND PREMIUM FREIGHT, LOWER PRODUCT SALES VOLUMES, AND UNFAVORABLE PRODUCT MIX, PARTIALLY OFFSET BY OTHER INCOME. PLEASE TURN TO SLIDE 10. IN THE FIRST QUARTER OF FISCAL YEAR 23, WE REDUCED GROSS DEBT BY $3.3 MILLION. SINCE OUR ACQUISITION OF GRAYCON IN SEPTEMBER OF 2018, WE HAVE REDUCED GROSS DEBT BY $150 Net debt, a non-GAAP financial measure, increased by $16.3 million to $54.8 million in the first quarter of fiscal year 23, from $38.5 million at the end of fiscal 22, mainly due to the share repurchases of $11.9 million and unfavorable working capital changes, especially related to inventory, which increased significantly due to the ongoing supply chain related challenges. We ended the first quarter with $152.4 million in cash. Our debt-to-trailing 12-month EBITDA ratio, which is used for our bank covenants, is approximately 1.3, well below our covenant threshold of 3.5. Our net debt-to-trailing 12-month EBITDA ratio was approximately 0.4. Please turn to slide 11. Fiscal year 23 first quarter free cash flow, a non-GAAP financial measure, was 3.1 million as compared to a use of cash of 6.2 million in the first quarter of fiscal year 22. The increase of 9.3 million was primarily due to favorable changes in net operating assets and liabilities. Lower net income of 7.6 million was offset by a favorable change of 10.6 million in working capital and 6.3 million less in capital expenditures. We expect free cash flow to improve the remainder of fiscal year 23 as we target reduced inventory levels and other positive working capital initiatives combined with increased net income, all while supporting increased CapEx. Regarding capital allocation, on June 16th, we announced a $100 million increase to our existing stock buyback program. During the first quarter of fiscal year 23, we bought back 317,000 shares for $11.9 million bringing the total program to date purchases of nearly 1.9 million shares, totaling 83 million, which leaves approximately 117 million of remaining capacity available for purchases as of the end of the first quarter. The current authorization expires in June 2024. Investing for future organic growth and vertical integration remains a key priority from a capital allocation strategy perspective. especially as we rationalize our global footprint for the future, including expanding our EV capabilities so we can better support our build where we sell strategy and continue to better position ourselves to capitalize on the EV megatrend. We have a strong balance sheet, and we'll continue utilizing it by continuing our investment in businesses to grow them organically. And in addition, we continue to pursue opportunities for inorganic growth with a measured return of capital to the shareholders. Please return to slide 12. Regarding fiscal 23 guidance, it is based on management's best estimates, including the impact of the COVID-19 pandemic, particularly in China, the headwinds from the ongoing semiconductor shortage, other supply chains disruptions, inflation, economic instability in Europe, and both short and long-term supply chain rationalization and restructuring efforts and their related impact on our financial results. All of these items, individually and collectively, still pose an ongoing challenge in this macroeconomic environment. While we have experienced some success in recouping some cost recoveries, we expect these headwinds will likely be with us for the remainder of fiscal year 23. The revenue range for the full fiscal year 23 is between $1,160,000,000 to $1,210,000,000. The anticipated growth at the midpoint of our range considers the full year impact of a large automotive program roll off, which has sales in fiscal 22 in excess of $100,000,000. The diluted earnings per share range is also unchanged at 270 to 310 and contemplates the continued above-mentioned headwinds from supply chain, inflation, and other macroeconomic events. Our estimated annual effective tax rate remains between 16% and 18% without any discrete items. We continue to anticipate CapEx of between 40 and 50 million as we expand our capabilities to support our growth in EV sales. and strategically position our global footprint to support production of our significantly increased order backlog that we built over the last two years. Estimated depreciation in the amortization expense remains between 54 and 58 million. In short, the first quarter was within our range of expectations, and our current view of the remainder of the fiscal year remains unchanged. As a reminder, based on the strong bookings we realized over the past two fiscal years, much of which is for the EV market, we announced a three-year organic compounded annual growth rate of approximately 6%. This CAGR considers the anticipated roll-off of relevant programs and reinforces that our organic growth strategy is putting the company on a solid future organic growth trajectory. The strong bookings momentum continued in the first quarter of fiscal 23. Don, that concludes my comments. Ron, thank you very much.

Ali, we are ready to take questions.

Thank you. Ladies and gentlemen, the floor is now open for questions. And if you have any questions or comments, please press star 1 on your phone at this time. We ask that while posing your question, you please pick up your handset if listening on speakerphone to provide optimum sound quality. Please hold while we pull through questions. Thank you. Our first question is coming from Luke Young with Baird. Sir, please go ahead.

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

Sure. When I look at the roll-off, the program, which we've anticipated for quite some time, I don't put a whole lot of weight to that. Several years ago, we booked EV programs that we saw from revenue that replaced that. The impact, even though we did recover some of our costs during the quarter, was from the ongoing supply chain issues, both wage inflation and logistics. those didn't exist in the quarter, I don't think we'd be talking about the roll off of a program. So those are, I think, mutually exclusive. What impacted auto is the macroeconomic conditions in Europe, which is a higher margin territory for us than in the United States. So the combination of the logistics and inflation as well as European sales and mix contributes to that.

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

Okay, thank you for that. And then my second question, just regarding the shape of the fiscal year, overall you're, you know, clearly starting with some improvement in earnings versus where the fourth quarter shook out from here. That, of course, is going to need to continue. Back of the envelope, if I do the math, take the midpoint of guidance in what you reported this year, or this quarter, I should say. That implies about 77 cents per quarter in EPS to get to that midpoint. Can you just comment on how you see that progression internally or maybe any key factors we should be considering relative to that anticipated progression on a quarterly basis?

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

Yeah, no, Luke, we anticipate improvement in each of the quarters coming up. I mean, historically, our third quarter tends to be maybe a little bit weaker than some of our other quarters. But we're going to see some momentum coming out of this quarter. In terms of the China lockdowns and some of the other programs that we'll have bringing to launch, you'll see we anticipate progression throughout the year in terms of EPS growth.

But, you know, we don't give quarterly guidance, but we do the same math, and achieving that, you know, on average per quarter is achievable. So we're confident in that going forward, short of a, another lockdown in China.

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

If I look quarter over quarter to bear a very strong quarter in the fourth quarter, 1.6 million in this quarter with .7. I don't read too much into that. The fourth quarter had a very large order and it actually a large order over half million and then a kind of a midsize order. And that's really dictated by when the evaluations are done by the hospital. They have been impacted by COVID. And the orders follow usually in the next quarter. So that's what happened in the fourth quarter, which was a great quarter. The first quarter, we didn't have the completion of any major evaluation. So that was weaker again. I think what DeBeer is experiencing was the long-term effect of COVID on their evaluation. So it kind of makes the order flow a little lumpy. But to your question, what are we expecting? In the $4 to $5 million range, we get the evaluations done. And I mentioned before, we almost always get business after an evaluation. They've all been successful, so I'm anticipating that the pace for DeBeer will pick up. And to the last part of your question, we remain confident in that business. The list of customers continues to grow. And we understand the issues it's had with evaluations, but we still remain confident in the business.

Okay, thank you. I'll leave it there.

Thank you.

Once again, ladies and gentlemen, if you have any questions or comments, please indicate so by pressing star 1 on your phone. Our next question is coming from John Franzreb with Sedoti. Please go ahead.

Good morning, guys, and thanks for taking the questions. Good morning. I'd like to start with the industrial business, record revenues. Was there anything unusual as far as timing in the quarter that helped achieve those revenues? Anything else coming in? And what are your expectations on the cadence in the industrial business for the balance of the years relative to the first quarter?

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

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

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

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

Okay, fair enough. And I guess two parts, I guess, to this question. You know, you just heard of a lockdown in China at Shandu. Can you, A, hit your 20% EV target without China coming back to some normalcy? And B, given the additional lockdowns we heard of today, is that kind of factored into your outlook or are you a little bit surprised by that?

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

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

I think we can. If your question is, if it stays status quo, can we hit the target? And our projections are yes. Again, I don't mean to repeat myself, but if it affects one of our plans dramatically, that will have an effect.

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

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

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

Got it. Great. Okay. Thanks, guys. Thanks for taking my questions.

Thank you.

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

Ali, thank you. We'll thank everybody for listening and wish everybody a safe and enjoyable Labor Day weekend. Goodbye.

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