Methode Electronics, Inc.

Greetings and welcome to the Method Electronics fourth quarter and full year fiscal 2023 results call. At this time, all participants are in listen-only mode and a question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Robert Cherry, Vice President of Investor Relations. Sir, you may begin.

Thank you, Operator. Good morning, and welcome to MetaElectronics Fiscal 2023 Fourth Quarter and Full Year Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2023 Fourth Quarter and Full Year 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.

Don Duda Thank you, Ron, and good morning, everyone. Thank you for joining us for our fiscal 2023 fourth quarter earnings conference call. I'm joined today by Ron Zumwitz, our Chief Financial Officer, and 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 a healthy $301 million. They were up 4% compared to the prior year, but up 9%, excluding a significant headwind from foreign exchange and a drop in material spot buy and premium freight cost recovery. The increase was mainly due to higher sales in the industrial segment driven by lighting solutions for commercial vehicles and by power distribution solutions for electric vehicles. The sales growth from lighting and power products is another data point in our strategic pivot to reduce our reliance on user interface solutions. In the quarter, we continue to face ongoing cost increases due to inflation in material and labor, which continue to be a drag on margins. The ongoing cycle of inflation and subsequent efforts to obtain price increases from customers is a persistent challenge. I cannot stress that enough. We can, however, report a significant reduction in spot buys and expedited shipping as supply chain constraints have improved over last year. On the order front, we have a very strong quarter with over $250 million in annual program awards. These programs were once again dominated by electric vehicle programs. The Nordic Lights acquisition, which is an exciting opportunity to grow our lighting franchise and gain more industrial and non-auto market exposure, is nearing completion. While we have secured over 99% of the outstanding shares, we're still working through the squeeze-out process for the remaining shares. Once that legal process is complete, we will be able to provide more information. Turning back to EV activity, Sales in the quarter were 23% of our consolidated total and were a record on a dollar basis. In regards to awards, we won over $215 million in annual EV awards in the quarter. Looking forward on EV, activity will be strong again in fiscal 2024, but will be very dependent on auto OEM take rates as well as the timing of program roll-offs. In the quarter, we had an increase in debt. which was driven entirely by the Nordic Lights acquisition. During the quarter, we purchased approximately $8 million of shares. Of the announced $200 million board authorization, we have now purchased $119 million in total. Prior to the Nordic Lights acquisition, this buyback program was a key focus of our capital allocation strategy. With the increased debt level, part of our focus will return to debt reduction. Lastly, but just as important than anything on the slide, we generated $38 million in free cash flow in the quarter, which is an indication of our attention to operational performance and a focus on generating cash in our business model. Moving to slide five. The awards identified here represent some of the key wins in the quarter and represent $258 million in annual sales at full production. As a reminder, the launch timing of most of these programs could be anywhere in the range of one to three years from now. The awards were mainly for power products associated with the EV skateboard architecture. The awards were also heavily weighted towards the United States, where EV coding activity has clearly picked up. In other areas, we're awarded programs for lighting, user interface, and sensor solutions for applications in commercial vehicles and e-bike. I would like to take a step back and reflect on our EV activity over the last three years. Since the beginning of fiscal year 2021, we have won approximately $600 million in EV awards. This award stream acts like a backlog of potential future business. There is little doubt that EVs will be driving our organic growth in the coming years. Turning to slide six in our fiscal 2023 highlights, we delivered sales growth for the sixth year in a row and finished with a record sale of $1,180,000,000 for the full year. Excluding foreign exchange and cost recovery, we had a 7% year-over-year sales growth. Material, labor, and overall manufacturing cost inflation challenges during the year took a toll on earnings. Clearly, we were disappointed in the cost recovery efforts with our customers. Those efforts continue, as well as other initiatives to improve manufacturing efficiencies. However, program awards were very strong, reaching over $435 million with over 75% in EV applications. The strength of our bookings gives me confidence that along with the aforementioned initiatives, we'll achieve the margin expansion that supports our guidance for fiscal 2025. We had record sales into EV applications, and they reached 21% of our total sales for the full year. Our free cash Flow generation was up 50 percent year-over-year and supported the purchase of $48 million of shares, as well as our ongoing dividend program. It was a challenging quarter and a year plagued by ongoing cost inflation headwinds. However, our worldwide team still delivered organic sales growth for the year. Moving to slide seven, looking forward, we're expecting a slight slowdown in sales for fiscal 2024, and then a significant ramp up of sales in fiscal 2025. I want to walk you through the basic drivers of this. As you can see from the slide, the net of program roll-offs and program launches is a sales headwind in fiscal 2024. While Nordic Lights will add to our sales, we expect headwinds in the commercial vehicle, data center, and e-bike markets. The net result of all this is a slight sales slowdown in fiscal 2024. In fiscal 2025, the net of program roll-offs and program launches becomes a tailwind. We also expect a tailwind from strengthening commercial vehicles, data centers, and e-bike markets. The net result is an 11 percent organic sales growth rate from fiscal 2024 to fiscal 2025. With the strong award pipeline from the past three years and the effort Method has made to transition its product portfolio further into lighting and power solutions, This fiscal 2025 guidance demonstrates that our business model is healthy and is positioned to prosper from the strategic steps that we've taken to grow the business. Turning to slide eight. In summary, Meadowhead had a number of successes in fiscal 2023. We achieved record sales in our industrial segment with growth of 29 percent. We delivered record sales in the EV applications We generated strong free cash flow. And lastly, we executed the acquisition of Nordic Lights. Turning to our look, due to the program roll-offs and the expected weakness in key markets, we expect to have lower organic sales in fiscal 2024. In addition, we will be making significant investments and launching over 20 new programs. These investments include significant tooling and increased staffing. This activity, along with multiple years of strong awards, will enable us not only to replace the sunsetting programs, but to organically grow the business 11% from fiscal 2024 to fiscal 2025. At this point, I'll turn the call over to Ron, who will provide more details on our fourth quarter and full year financial results, as well as more details on our outlook. Ron. Thank you, Don. And good morning, everyone. Please turn to slide 10. Fourth quarter net sales were $301.2 million compared to $287.7 million in fiscal 22, an increase of 4.3 percent. This quarter sales had $7.7 million unfavorable currency impact and $2.5 million favorable spot buy and premium freight cost recovery impact. Also impacting the quarter's prior year comparison was the roll-off of a large automotive program in North America. Excluding the foreign currency in year-over-year cost recovery impacts, sales increased by 8.8%. The strength in the quarter was driven by lighting solutions in commercial vehicles and power solutions in EV. EV product applications were 23% of sales in the quarter. Fourth quarter income from operations decreased 41.8% to $8.5 million from $14.6 million in fiscal 22, mainly due to acquisition costs, material cost inflation, and unfavorable foreign currency translation. Partially offsetting those factors was the higher sales volume. Adjusting for acquisition costs of $6.8 million and costs related to the reorganization of a foreign subsidiary of $0.5 million, our non-GAAP adjusted income from operations increased 8.2% to $15.8 million from $14.6 million in fiscal 22. Please turn to slide 11. Fourth quarter diluted earnings per share decreased 48.8 percent to 22 cents per share per diluted share from 43 cents per diluted share in the same period last fiscal year. The EPS was negatively impacted from the acquisition costs, material cost inflation, and unfavorable foreign currency translation. Adjusting for the net acquisition cost of 6.6 million and the net benefit related to the reorganization of a foreign subsidy area of 7 million, our non-GAAP adjusted diluted EPS decreased 51.2% to 21 cents per diluted share from 43 cents in fiscal 22. Shifting to EBITDA, a non-GAAP financial measure, fourth quarter EBITDA was 21.9 million versus 30.8 million in the same period last fiscal year, a 28.9% decrease. EBITDA was negatively impacted by acquisition costs, material cost inflation, and the unfavorable foreign currency translation. Higher sales volumes helped to partially offset the decrease. Adjusting for acquisition costs of $6.8 million and costs of $2.6 million related to the reorganization of a foreign subsidiary, our adjusted EBITDA increased 1.6% to $31.3 million from $30.8 million in fiscal 22. Please turn to slide 12. We increased gross debt by 96.3 million for the full year, mainly due to the Nordic Lights acquisition. We ended the year with 157 million in cash, down 15 million for the full year. During the quarter, we bought back shares for 8.5 million, bringing the year-to-date total to 48.1 million. Net debt, a non-GAAP financial measure, increased by $111.3 million to $149.8 million in the full year from $38.5 million at the end of fiscal 22. Again, the main driver of the increase was the Nordic Lights acquisition. Our debt-to-trailing 12-month EBITDA ratio was approximately 2.2. Our net debt-to-trailing 12-month EBITDA ratio was approximately 1. We continue to have solid debt capacity, which offers the company flexibility from a capital allocation perspective, especially for inter-granted growth initiatives. Please turn to slide 13. Fourth quarter net cash from operating activities was a healthy $49 million as compared to $42 million in fiscal 22. The increase of $7 million was primarily due to working capital improvements in the quarter. Fourth quarter capital expenditure was $11.2 million as compared to $8.4 million in fiscal 22, an increase of $2.8 million. The increase was mainly a function of a lower level of spending in the prior year quarter as the spending level this quarter was in keeping with our guidance. Fourth quarter free cash flow, a non-GAAP financial measure, was $37.8 million as compared to $33.6 million in fiscal 22, an increase of $4.2 million. This increase, again, was primarily due to working capital improvements. We continue to have a strong balance sheet, and we will continue to utilize it by investing in our businesses to grow organically and by pursuing opportunities for inorganic growth. Please turn to slide 14. Fiscal 23 net sales were a record $1,179,600,000 compared to $1,163,600,000 in fiscal 22 an increase of 1.4%. This was our sixth year in a row of record sales. This year's sales had 57.3 million unfavorable foreign currency impact and 20.9 million favorable spot buy and premium freight cost recovery impact. Excluding the foreign currency and year-over-year cost recovery impacts, sales increased by 6.5%. The strength of the year was driven by our industrial segment EV product applications were 22% of sales in the year. Negatively impacting the year was the roll-off of a large automotive program in North America. Fiscal 23 income from operations decreased 19.1% to $90.4 million from $111.7 million in fiscal 22, mainly due to acquisition costs and material inflation, which were partially offset by higher sales volume. Adjusting for the acquisition cost of $6.8 million and costs related to the reorganization of a foreign subsidiary of $0.5 million, our non-GAAP adjusted income from operations decreased 12.5% to $97.7 million from $111.7 million at fiscal 22. Please turn to slide 15. Fiscal 23 diluted earnings per share decreased 22.2% to $2.10 from $2.70 per diluted share last fiscal year. The EPS was negatively impacted from the acquisition costs and material cost inflation, which were partially offset by a net tax benefit related to the reorganization of a foreign subsidiary. Adjusting for the acquisition cost of $6.6 million and net benefit related to the organization of a foreign subsidiary of $7 million, our non-GAAP adjusted diluted EPS decreased 22.6% to $2.09 from $2.70 in fiscal 22. Shifting to EBITDA, the full year EBITDA was $142.3 million versus $174.6 million last fiscal year, an 18.5% decrease. EBITDA WAS NEGATIVELY IMPACTED BY THE ACQUISITION COST AND MATERIAL COST INFLATION, WHICH WERE PARTIALLY OFFSET BY HIGHER SALES VALUE. ADJUSTING FOR THE ACQUISITION COST OF $6.8 MILLION AND THE COST OF $2.6 MILLION RELATED TO THE REORGANIZATION OF A FOREIGN SUBSIDIARY, OUR ADJUSTED EBITDA DECREASED 13.1% TO $157.1 MILLION FROM $174.6 MILLION IN FISCAL 22. PLEASE TURN TO SLIDE 16. Fiscal 23 net cash from operating activities was a healthy $132.8 million as compared to $98.8 million in fiscal 22. The increase of $34 million was primarily due to working capital improvements. Capital expenditure was $42 million as compared to $38 million in fiscal 22, an increase of $4 million. The increase was mainly a function of a low level of spending in the prior year as the spending level this year was within guidance. We expect significant increase in CapEx in fiscal 24 to increase capacity and capability for the increased launches in both fiscal 24 and fiscal 25. Free cash flow was $90.8 million as compared to $60.8 million in fiscal 22, an increase of $30 million. This increase, again, was primarily due to working capital improvements. Please turn to slide 17. Regarding forward-looking guidance, it is based on management's best estimates and is subject to a change due to a variety of factors noted on this slide. While we have experienced some success in price increases to offset the ongoing material cost inflation, we expect this headwind will still be with us in fiscal 24. The expected net sales range for fiscal 24 is $1,150,000,000 to $1,200,000,000. The expected diluted earnings per share range is $1.55 to $1.75. This fiscal year 24 guidance includes the Nordic-like acquisition, assumes an income tax rate of between 18 and 20 percent with no discrete tax benefits or expenses. It assumes CapEx in the 65 to 75 million range and assumes depreciation and amortization in the range of 57 to 62 million. The fiscal year 24 EPS cadence will be somewhat uneven with the first quarter being weakest, largely due to the anticipated contingent legal fees related to the heteronic lawsuit. We anticipate minimal sequential quarterly EPS growth from the fourth quarter of fiscal 23. Looking further ahead to fiscal 25, the expected net sales range is between $1,250,000 to $1,350,000. The midpoint of this range represents 11% organic growth from the midpoint of the fiscal year 24 net sales guidance range. The expected range income from operations as a percentage of net sales in fiscal year 25 is 11% to 12%. The fiscal year 25 income tax rate is expected to be between 20 and 22% with no discrete tax benefits or expenses. Don, that concludes my comments. Ron, thank you very much. Operator, we are ready to take questions.

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is coming from John Franzrup with Sedoti and Company. You may proceed.

Good morning, guys, and thanks for taking the questions. I'd like to start with a couple of quick clarifications. First and foremost, it looks like Nordic is part of the balance sheet. I'm curious if it's part of the P&L, too, because I didn't hear any mention of any revenue contribution from Nordic in the fourth quarter. So can you just kind of walk me through that?

Yes, you're absolutely correct. It's on the opening balance sheet, but we did not have any profit and loss activity in fiscal 23 related to Nordic Lights due to its very late closing right prior to the end of the fiscal year.

Got it.

And there will be in fiscal 24. Yep. Okay.

All right, so you mentioned legal fees that you're going to continue to incur from Nordica. Are there any other cash expenses that we should be worried about or incremental debt that you're going to have to bring on board that will be part of Q1 that was not part of Q4?

No, we mentioned...

from a legal expense perspective, the Supreme Court ruling, if that comes through next week, that we could have the contingent legal fee related to that matter in the first quarter. I think from a, we would not expect to take on any further debt in the first quarter, and if anything, depending on cash flows and how everything's going, we might even de-lever a little bit.

Okay, I'm sorry.

Eric? Interest rates, yeah, interest rates, you know, obviously are something, cost of borrowing has gone up and we have some fixed interest, variable to fixed interest rate swaps that will be expiring. So we do expect an increase in debt, higher interest expense, significantly higher interest expense in fiscal 24 as compared to fiscal 23.

Since you brought it up, what is your expected interest expense embedded in your guidance for fiscal 2024?

It's in the about $13 million-ish range, somewhere around there.

Okay, perfect. And let me just switch gears real quick. On the program roll-offs, just to clarify, you mentioned the impact in 2023 of the North American program roll-off that we've been talking about for quite some time. Two questions here. One, how much was that impact in the fourth quarter? And secondly, when you're talking about the fiscal 2024 guidance, it's a plural. It's program roll-offs. So in addition to the one that we've been going through, what's the incremental number on top of that from new program roll-offs?

Hang on a second here.

So the program roll-offs in total, we would expect around $150 million. Yeah, I agree.

And how much of that is left over from the one that we've been incurring in 2023?

So it would be approximately, from that program, another $100 million. And then there's another program in the EV space that would take a lot of the balance of that.

Perfect. That's what I was looking for. You know what? I've been taking a lot of time, guys. I'll get back into queue for follow-ups. Thank you.

Thanks, John.

Thank you. Our next question is coming from Gary Prestapino with Barrington Research. You may proceed.

Hey, good morning, everyone. My question, it kind of revolves around what the last question here was, but In terms of this North American program roll off. Is that over in fiscal 24 or is there some residual going into fiscal 25 with, again, there's a plural roll offs there. The in round numbers that roll off. In 25 and then I talked about in 24 their headwind in 25, our increased business becomes a tailwind, even with about 120 million of roll-offs in fiscal 25. Right, I understand that, but I'm trying to get at, I guess, let me just ask you, is the North American roll-off over in fiscal 24, or is there still some residual in fiscal 25? That depends on the customer.

Okay.

There could be some additional business in 25. It depends when they launch their new programs. I really can't get into too much of that, but we have seen programs extend a little longer. So there could be some of that in 25. Gary, I think what I would say too about the other program is The one that started rolling off in fiscal 23 that's rolling off in 24, the preponderance of the roll-off will be done by the end of fiscal 24. There will be a sum and carryover in 25, but the preponderance is in 23 and 24. Yeah, and I don't look at that extending into 25 as a huge upside. It's just the timing of the customer's launch. Okay, that's kind of what I was getting at. Thank you for that answer. And then in terms of the DNA range for fiscal 24, how does that break down between depreciation and amortization? Can you give us some rough numbers there? I guess at a high level, 20-ish million in the A part and the rest in the D part. Okay, thank you. And then I also want to just ask in terms of it's great you've got all these new product launches. Could you maybe detail, first of all, what are some of the expenses that are up front that are associated with these new product launches? And then are we, as we model things out, is the expense front end loaded in Q1, Q2, and then you start generating, you know, less level of expenses or less upfront expenses and then revenues start to accelerate from the new programs in the back half of fiscal 24. Could you help us out with that, please? Sure. It is equipment. It is people. It is prototyping costs that we're starting to incur and will continue to incur throughout fiscal 2024. As we get into the end of 24, those costs will start to be absorbed into the product launches. Okay. So the factored into the guidance, and we will, we are starting, we've been hiring, we've been procuring equipment. The plant is probably 30%, complete from the equipment standpoint. So that will continue throughout the year, and then we will be launching a lower volume at the end of the year. It's not a significant amount, but it will start to absorb the costs. All right. And I know you didn't give this as a point of your guidance, but it looks like you had almost a 13% adjusted EBITDA margin in fiscal 23. Given the range of what you've given us for fiscal 24. Where do you see that adjusted EBITDA margin range if you have that calculation handy? Well, in terms of the range, it would be somewhat comparable to this fiscal year. Our fiscal 24 from EBITDA margin percentage as a percentage of sales so it'd be comparable to fy 23 that's what you're saying yes okay all right all right thank you very much thank you

Thank you. Once again, if you have any questions or comments, please press star 1 on your phone at this time. Our next question is coming from Matt Sheeran with Stifel. Sir, you may proceed.

Yes, good morning and thanks for taking my questions. I have a couple of quick questions. One, your commentary in terms of your outlook for data centers looks like that will continue to be a headwind. Is that due to the inventory build at the hyperscale customers that are yet to work off? And are you having any visibility in terms of that picking up in the back half of your fiscal 2024? And then the second question, in your preliminary earnings release, your pre-announcement a couple of weeks ago, you talked about a sunsetting of an EV program due to a change in technology by that customer. Could you be more specific about what that technology changes and how that may impact you on other programs? Thank you.

Okay. I probably can't answer that exactly. I can't give you detail on that because of the customer. I can tell you this. It is one customer, one product. We do not sell that product to other customers. Of course, I don't want to lose the business, but I understand it. But it does not impact our strategic thinking in terms of EVs. It is on the top hat, which there's more volatility on the top hat as there are on passenger cars or on ICE cars as well. Does it concern me long-term? No. Would I like the business to say yes? I understand it, but I apologize. I can't really go into any more detail than that. I have to be respectful of the contract we have with the customers and the customer we continue to do business with. Do you have a question? More of an inventory, over inventory. Do I... expect that to maybe improve it towards the tail end of the year? We don't think so. We haven't put that into our numbers. Could it? But when I look at commercial vehicles alone, and I know you're asking about data centers, but ACT has the market down 29%. And they're not always market people aren't always spot on, and we're not spot on. But that's a definite direction and a headwind we're going to face in 24. And in 25, they have it going back up.

Got it. And just so on data center, you're just not getting visibility into that picking up anytime soon.

No, and we know, I mean, we know when we ship the customer, we kind of know their usage, and they told us they're over-inventory. So until they work that down, and we can, you know, We can model, here's what they've taken in the last three quarters, and if they have all that in inventory, you can pretty much expect you're not going to have much business for the next three quarters. We have visibility to that, and that's why we're guiding them.

Fair enough. Okay, thanks very much.

Well, thank you. I want to make a just quick clarification. What Gary's question, the A part of DNA will be about 25 million instead of 29. I think I said 25 is the correct answer. Thanks, Ron.

Thank you. As we have reached the end of our question and answer session, I will turn the call back over to Mr. Duda for any closing remarks.

Thank you. We will thank everyone for their questions and for listening and wish everyone a very safe and enjoyable summer. Good day.

Thank you. This concludes today's conference and you may disconnect your lines at this time. And we thank you for your participation.