Methode Electronics, Inc.

Greetings and welcome to the Method Electronics second quarter fiscal 2024 results call. At this time all participants are on a 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 Metro Electronics' Fiscal 2024 Second Quarter Earnings Conference Call. For this call, we have prepared a presentation entitled Fiscal 2024 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 laws. Method Runner takes no duty to update any forward-looking statement to conform the statement to actual results or changes in Method's expectations on a quarterly basis or otherwise. The forward-looking statements in this conference call involve a number of risks and uncertainties. The factors that could cause actual results to differ materially from our expectations are detailed in methods filings with the Securities and Exchange Commission, such as our 10-K and 10-Q reports. At this time, I'd like to turn the call over to Mr. Don Duda, President and Chief Executive Officer.

Thank you, Rob, and good morning, everyone. Thank you for joining us for a fiscal 2024 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 on slide four. Our sales for the quarter were a solid $288 million. Sales were down year over year, primarily due to program roll-offs, a tough comp to the prior year in Asia due to COVID-delayed sales in China, continued softness in the e-bike market, and, of course, the impact from the UAW strike. All of these headwinds hit our auto segment. Sales in the quarter were helped by the acquisition of Merck Lights in the industrial segment. Turning back to the auto segment, in the quarter, we were required to take a non-cash goodwill impairment totaling $57 million related to the North American Auto and European Auto Reporting Units. Ron will go through the financial mechanics later in the call, but the summary of the situation is that with the recent operating property weakness in our North American auto reporting unit, the accounting rules required us to review our goodwill, which in turn led to the impairment. Also in the quarter, we continue to experience operational inefficiencies in our North American auto operations that manifested in the first quarter. As you may recall, they were caused primarily by salary personal turnover, poor operational decisions and vendor issues, which led to subsequent production planning deficiencies. This in turn had a domino effect leading to inventory shortages, unreimbursed spot purchases, and premium freight and labor. In a lean manufacturing environment, disruptions like this can ultimately generate significant costs to address material shortages and maintain customer delivery integrity. In auto, Delivery, in addition to quality, is absolutely paramount to both maintaining current and obtaining new business. I want to stress that we have not let our internal inefficiencies negatively affect our customers. We also continue to see increased expenses related to our numerous new program launches, some of which are now also being delayed. I am confident that these operational challenges have now been largely identified and corrective action plans are actively being executed. However, the residual effects are now expected to linger longer than we previously communicated and will impact the remainder of our fiscal year. In fact, they are the cause of approximately half of our reduction to adjusted earnings guidance for the full year. It is not lost on me that last quarter, we were overly optimistic with the time required to remedy this situation. On a more positive note, we are pleased with the Nordic Lights acquisition, which is now fully under methods control. The business is performing as expected and integration efforts are underway. Moving to orders. We had a modest quarter with over $20 million in annual program awards. These programs are once again led by electric vehicle programs. As we often communicate, our order trend is rarely linear and often ebbs and flows. I can share that the pipeline of potential awards remains strong. In fact, we have near-turn opportunities to win business due to smaller bus bar competitors who are not performing to the OEM's expectations. Turning back to EV activity, sales in the quarter were 19% of our consolidated total. In regards to awards, We won over $15 million in annual EV program awards in the quarter. For fiscal 2024, sales activities will be strong, but we'll still be very dependent on the OEM take rates as well as the timing of EV program launches. In the quarter, we had an increase in debt, which is driven by an investment in working capital to support our sales and launches. While our debt and consequently our leverage has increased, it is still at a reasonable level. As such, we're very comfortable with our flexibility for capital deployment, whether it's for internal investments or share buybacks. With the Nordic Lights acquisition behind us, we resumed our share buyback in the quarter, acquiring just under $8 million in shares. Given the low net income in the quarter, we consequently had negative cash flow. With the expected lower net income for the full year, We now expect free cash flow to be neutral for fiscal 24 but will be positive in fiscal 25. Turning to slide five. In summary for the quarter, sales were solid despite several headwinds. The Nordic Lights acquisition is complete and the business is performing well. We continue to have a heavy focus on improving operational efficiency and executing new program launches. Lastly, we resumed our share purchase program. Looking at the remainder of Fiscal 24 and into Fiscal 25, we have a definitive path forward and I would like to clearly articulate. Our Fiscal 24 has been challenged by auto program roll-offs and market headwinds in commercial vehicles, data centers, and e-bikes. The year has also been hindered by unacceptable but fixable operational shortcomings, which are taking longer to resolve than originally anticipated. Lastly, we've experienced substantial price cost pressure during the year, which we're addressing via pricing and increased cost improvement initiatives, such as vendor price reduction and value engineering. As such, fiscal 24 is a pivotal year of investment and transition with the objective of a clean start to fiscal 25. As mentioned, we're launching over 20 new programs this year, which require significant investment and resources. That ongoing investment is in items like facility preparation, product qualifications, staffing and training expenses, along with the additional costs required to ensure that our operational issues this year have required us to lower fiscal 2024 guidance. For our third quarter, we now expect a modest improvement over the second quarter. We then expect further improvement in the fourth quarter. Turning to fiscal 25. Our outlook continues to be positive, supported by multiple years of strong awards. However, the year will be very dependent on a number of items, including but not limited to EV OEM launch schedules and take rates, a rebound in the e-bike, commercial vehicle, and data center markets, and further market inroads with our lighting franchise. While we have confidence in our ability to execute in that environment, some factors will simply be out of our control. Of particular concern is the EV market. Our outlook for EV remains very positive long term, but in the near term it is tempered by program delays and moving take rate projections. However, we have no doubt that this market will fuel our growth over the next three years. As such, we've reduced our guidance for fiscal 2025 mainly due to the EV market trends. To illustrate, we've had one major EV program get partially delayed from fiscal 25 to fiscal 26. To summarize, we're decisively making the investments in fiscal 24 to ensure profitable growth in fiscal 25. We firmly believe that our business model is healthy and is positioned to prosper from this strategic direction that we have taken into lighting and power solutions to grow the business. Turning to slide six, in order to give you a more granular picture of our sales guidance, we've updated the bridge that we provided last fourth quarter for our guidance walk from fiscal 23 to 25. Our program roll-offs, while still sizable, have been less this year than expected, but will be now more next year. However, the most notable change is that new program launches in fiscal 25 have been reduced by approximately $70 million due to customer delays into fiscal 26. Together, these drivers have caused us to lower our fiscal 25 guidance by $100 million at the midpoint. At this point, I'll turn the call over to Rob, who will provide more details on our second quarter financial results, as well as more details on our outlook.

Thank you, Don. And good morning, everyone. Please turn to slide eight. Second quarter net sales were $288 million, compared to $315.9 million in fiscal 23, a decrease of 9%. This quarter sales included 20.9 million from the Nordic Lights acquisition and 3.5 million from favorable foreign currency translation. Excluding Nordic Lights and foreign currency sales decreased by 16.6 percent. The quarter saw the continuation of two key automotive program roll-offs, one in North America and one in Asia. We also had a difficult comp in Asia As in the prior year, Asia benefited from sales that were delayed from the first quarter to the second quarter as a result of the COVID shutdowns in China. The quarter also saw lower sales for e-bike sensors as that market continues to be overstocked. That inventory headwind is expected to last at least through the end of this fiscal year and potentially into next fiscal year. Second quarter loss from operations was $51.3 million down from 32.8 million of income in fiscal 23. The major factor in the decrease was a goodwill impairment charge of 56.5 million. At the end of the second quarter, we experienced a goodwill impairment triggering event when our market cap was less than our book value. Based on the triggering event, we performed a quantitative analysis of our two reporting units and determined that the current fair value of the goodwill was less than the carrying value, resulting in an impairment at two of our automotive reporting units. Income was also down to lower sales volume and the ongoing operational inefficiencies, which drove higher premium freight and labor expenses. Adjusting for the goodwill impairment of $56.5 million, restructuring costs mainly related to the exit from De Vere of $0.6 million and costs related to the Nordic Lights acquisition of 0.2 million, our non-GAAP adjusted income from operations was $6 million. Please turn to slide nine. Second quarter diluted earnings per share decreased to a negative $1.55 from a positive 75 cents in the same period last fiscal year. The EPS was negatively impacted by the goodwill impairment, the lower operating income, and the higher net interest expense. A tax benefit in the quarter as compared to a tax expense in the prior fiscal year was a partial offset. Adjusting for the goodwill impairment of $1.58, restructuring costs of one cent, a loss on sale of assets of one cent, and purchase accounting adjustments related to inventory of one cent, our non-GAAP adjusted diluted EPS decreased to six cents per share. Shifting to EBITDA, a non-GAAP financial measure, Second quarter EBITDA was a negative $36.7 million versus a positive $46.1 million in the same period last fiscal year. EBITDA was negatively impacted by the goodwill impairment, lower operating income, and higher selling and administrative expenses. The contribution from Nordic Lights helped partially offset the decrease. Adjusting for the goodwill impairment, restructuring costs of $0.6 million loss on sale of assets of 0.6 million, and purchase accounting adjustments related to inventory of 0.2 million, our adjusted EBITDA decreased 55 percent to 21.2 million. Please turn to slide 10. We increased gross debt by 25.2 million in the quarter, mainly due to working capital investments and higher CapEx, both to support sales and new program launches. We ended the quarter with $122.5 million in cash, down $34.5 million from the end of the last fiscal year. Net debt, a non-GAAP financial measure, increased by $59.7 million to $209.5 million for the quarter, up from $148.9 million at the end of fiscal 23. Again, the main drivers of the increase were an increase in working capital and higher CapEx. Please turn to slide 11. Second quarter net cash from operating activities was an outflow of 0.6 million as compared to an inflow of 15.4 million in fiscal 23. The decrease of 16 million was primarily due to lower net income in the quarter. Second quarter capital expenditure was 10.7 million as compared to 8.4 million in fiscal 23, an increase of 2.3 million. The increase was mainly a function of investments to support new program launches and was keeping in line with our guidance. Second quarter free cash flow, a non-GAAP financial measure, was a negative $11.3 million, as compared to a positive $7 million in fiscal 23, a decrease of $18.3 million. This decrease, again, was primarily due to reduced net income and increased capex. Please turn to slide 12. Regarding forward-looking guidance, it is based on management's best estimates and is subject to a change due to a variety of factors as noted in the bottom of the slide. Net sales for our third quarter should be similar to our second quarter. However, the operational efficiencies experienced in the second quarter will carry over to the third quarter and likely into the fourth quarter. This is longer than we had previously estimated. As a result, the expected adjusted diluted earnings per share in the third quarter will only be modestly higher than the second quarter. Turning to the full year, the expected next sales range for fiscal 24 is still $1,140,000,000 to $1,180,000,000 unchanged from the previous guidance. The expected diluted earnings per share range is now a negative $1.40 to a negative $1.14, down from a previous range of a positive $0.80 to $1.00 per share. The drop is predominantly related to the goodwill impairment and continued operational efficiencies at North American Automotive. Adjusting for the $1.58 goodwill impairment, $0.04 of costs related to the DeBeer exit and $0.02 related to the Nordic Lights acquisition, the expected adjusted diluted earnings per share range is $0.24 to $0.50, down from $0.88 to $1.08. This fiscal 24 guidance assumes an income tax rate of 14% to 16% in the second half of the year with no discrete tax benefits or expenses, assumes capex of $60 to $70 million for the full fiscal year, and assumes depreciation and amortization of $55 to $60 million. There have been no changes to any of those three items. Looking further ahead to fiscal 25, the expected net sales range is now $1,150,000,000 to $1,250,000,000, down from $1,250,000,000 to $1,350,000,000. The midpoint of the new range is lowered by $100,000,000 primarily due to the EV customer program delays into fiscal 26. The expected range of income from operations as a percentage of net sales in fiscal 25 is now 6 to 8 percent, down from 11 to 12 percent. This reduction is mainly due to the $100 million net sales reduction and its impact on overhead absorption. It still represents a significant improvement over fiscal 24 and is on par with what METHO delivered for operating margin in fiscal 23. The fiscal 25 income tax rate is expected to be between 20 and 22 percent with no discrete tax benefits or expenses. The increase in the tax rate from the current fiscal year is largely due to the estimated impact from the anticipated adoption of the Pillar 2 Minimum Global Tax Initiative. Don, that concludes my comments.

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

Thank you sir. 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. A 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 Luke Young with Baird. Your line is live.

Good morning. Thanks for taking the questions. Good morning. Good morning. Don, hoping to start with just the ongoing inefficiencies in North America. Of course, they came to the surface last quarter. You put corrective actions in place, and the prior guidance had implied we should be seeing some lift in the second half of your fiscal year in the bottom line. With guidance now moving lower today, just hoping to put a finer point on what changed in the expectation. Are the actions not having the desired effect? Are you seeing additional headwinds in the back half? Just anything to help us understand the bridge from the old expectation to the new, especially where maybe you were overly optimistic previously. Thanks.

Sure. As I said, I was overly optimistic. It is taking us longer to go through the various routings and part numbers and make corrective actions. To give you more color on that, these issues probably existed prior to this fiscal year, but they were masked by very high inventory in certain areas. And we took, and normally we do when we try to lean out our operations, we brought inventory down. One of the analogies that the lean experts sometimes use is the pond. And you lower the pond, you find the rocks. We found boulders. And it took us much longer. It is taking us longer to correct. They're all, as I said, all fixable. But it's a mismatch between our various systems. We do manufacture product in Dongguan, China. That's shipped to Monterey. engineering changes weren't recorded properly. And we said a lot of it was due to solid personal turnover that there was a certain amount of knowledge or that probably got lost at the end of COVID. So it's really dealing with routings, MRP, lead time. We had some lead times in the system at two weeks when it probably should have been closer to two months. Also, we saw changing I don't know if this is a COVID leftover, but we're seeing tremendous changes in schedule, something that we have not seen much in the past, and that also puts a stress on the system. So, Ron, is there anything that... Not from an operational perspective, I think you... And there was probably a lag on some of the invoicing. You don't get invoiced the next week for premium shipments, and there's probably a... Some of that occurred in the first quarter. They carried over in the second quarter. Again, all fixable. It's just we underestimated the amount of time.

And then just to maybe put a finer point on that, Don, what I'm hearing is more of these actions are continuing, but in terms of the corrective actions, it doesn't sound like you're necessarily needing to put new actions into place, or it's more a scope issue, not that there's kind of new problems that you found? Is that right?

That's correct. It's really a time factor that we uncovered nothing new that would cause us to change anything, change any of our actions.

Got it. That's helpful. And then for my follow-up, just hoping to understand how you incorporated updated expectations for EV volumes. And specifically what I'm hoping to tease out is how much this is a timing delay in terms of the new fiscal 25 guidance. You mentioned the program that had slipped partially from 25 into 26 versus just absolute reductions in your expectation for take rates. I don't know if there's any anecdotes on that latter piece in terms of take rates that you can share just to help us understand the level of conservatism that's in this new fiscal 25 guidance. Thank you.

We had two of our long-term vice presidents do a deep dive into our forecasting and overlaid that with the various expectations that we were hearing from our customers, our forecast, along with LMC and IHS, and what program delays we knew about. And that really is what contributed to the change. We're four months plus out from 25, and I'm sure there will be additional revisions as we get closer to giving guidance. could go up. One of the reasons we still have 1250 as the upside is there are some opportunities that are surfacing on some of the smaller competitors that are having difficulties that are presenting us some opportunities. So in general, it's just we did a deep dive into the forecast and adjust the guidance accordingly. From my standpoint, is the EV market collapsing or is there a major problem? No. I don't know if I want to use the phrase over exuberance, but there's probably some of that in the forecasting by the market. But I fully believe that, you know, 25 will be a good year for us, and 26 will be a better year. But we're going to see some fluctuations in forecasts until the industry really sorts out what's really the adoption level. Got it.

I'll leave it there. Thanks, Tim.

Thank you.

Thank you. Once again, ladies and gentlemen, if you have any questions or comments, please press star 1 on your phone. Our next question is coming from Gary Prestapino with Barrington Research. Your line is live.

Good morning, all. Good morning, Gary. Could you refresh my memory? Are your EB programs, what is the split there between commercial vehicles like last-mile delivery vehicles and regular passenger cars?

On our largest program, I want to say it's probably 80, 20, 20-something the last mile, maybe slightly higher than that. I don't know what we revised that to, but it's still probably in that range. I've said before, I like the last mile vehicles. They are definitely cost effective for the Amazons of the world. So we do place emphasis on that. And our largest program part of that is last mile.

But you say it's about 80, 20 passenger to last mile? Yeah. Yes. Yeah. OK. That's fine. Thank you. And then just getting into this write down again, Exactly. Could you just briefly explain what happened? Your actual book value or your market value fell below book, and by accounting convention, you had to test your goodwill, and that caused a write-down. Is that very simply how to phrase it?

That's correct, Gary. At the last day of the quarter, the closing stock price, our market cap was less than our book value of the company, and that is deemed a trigger. And we go back to the business units that have goodwill rerun the projections and all that valuation performed and came up with the the impairment amounts on two of those reporting units. OK, it just we do test for this annually each year about when there's triggering events in between the annual impairment tests we we do. test in between the annual ones. And this is what happened in this particular quarter.

So the trigger wasn't anything about the performance of the divisions. It was really, or the auto, it was just a trigger by accounting conventions of your market value went below your book.

Correct. That was a triggering value, the triggering event. And then we recast all of the projections as part of this. We recast all of the projections. for the current fiscal year and going out forward. And that's used to develop the models for the discounted cash flows and then to bring that back to present value and then assess whether the carrying value is higher than the or not of the fair value, and that is compared. And then the impairment was taken at the two businesses in excess of $56 million.

Doing an impairment like this on a longer-term basis, does this really change your outlook for what your capital spending would be, particularly with the businesses that had the impairment hit?

Go ahead. First of all, and then, Don, you can interject. You know, it's more about the impairment resulted from more about acquisitions that occurred in the past. Okay. performance of those cash flows, and that doesn't necessarily mean that you're not going to reinvest in the business. Obviously, North American auto, they're doing a lot of investment in support on new programs. So that part of it is forward-looking. The impairment and the goodwill that was created was, you know, backward-looking.

Thank you very much. Appreciate it.

Thank you. As we currently have no further questions on the line at this time, I would like to hand it back over to Mr. Duda for any closing comments he may have.

Thank you very much. I want to thank everyone for listening and for their questions and wish everyone a very safe and enjoyable holiday season. Good day.

Thank you. Ladies and gentlemen, this concludes today's conference and you may disconnect your lines at this time. We thank you for your participation.