Methode Electronics, Inc. (MEI) Q3 2021 Earnings Report, Transcript and Summary

Good morning and welcome to the Methode Electronics Third Quarter Fiscal 2021 Results. At this time, all participants are in a listen-only mode. [Operator Instructions] It is now my pleasure to turn the conference over to your host, Rob Cherry, Vice President of Investor Relations. Sir, the floor is yours.

Thank you operator, good morning and welcome to Methode Electronics fiscal 2021 third quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2021 Third Quarter Financial Results, which can be viewed on the webcast of this call or found at methode.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. Methode undertakes no duty to update any forward-looking statement to conform the statement to actual results or changes in Methode'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 Methode'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 and thank you for joining us today for our fiscal 2021 third quarter earnings conference call. I'm joined today by Ron Tsoumas, our Chief Financial Officer. Both, Ron and I have opening comments and then we will take your questions. Let's begin with the business highlights on Slide 4. Our sales for the quarter were $295 million. As noted in our release this morning, the company’s accounting period for this quarter included 13-weeks as compared to 14-weeks for the third quarter of 2020. Our discussions on year-over-year comparative results should be viewed in this context. For illustration, our sales on a weekly run rate basis and excluding favorable currency translation were up 8% from the prior year. We share this to give investors insight on how we view the underlying strength of our business which clearly improved year-over-year. While the topline was strong, we do have some headwins to gross margin in the quarter. Supply chain disruptions led to additional cost such as premium freight as well as to factor inefficiencies. Moving forward these challenges will linger and be joined by demand disruptions caused by on-going semiconductor and potentially order material shortages some of which are related to the recent extreme weather events in the U.S. This is driving a level of near term uncertainty that can be seen in our wide guidance range for the fourth quarter. However, none of these issues are systemic and we expect most to be resolved by the middle of this calendar year. Our confidence in this situation improving is evidenced by a decision to give an early indication of our anticipated sales for fiscal 2022 of over 10% organic growth. In addition as the commercial vehicle market continues to rebound, our sales mix is expected to further improve gross margin. Turning to our automotive business, we continue to see strength and demand. Our sales and EV grew and we had a strong word for Power, Lighting & User Interface programs in the quarter. Focusing on EV, last quarter we reported that sales into EV applications were over 9% of consolidated sales, and were expected to be in the high single digits for fiscal 2021. This quarter, EV sales were over 12% of consolidated sales and we now expect that number to be over 10% for fiscal 2021. Furthermore, our healthy pipeline of EV programs now gives us visibility to project that this percentage will be in the mid-teens in fiscal 2022. Methode’s combination of User Interface, LED Lighting & Power Distribution Solutions is a winning formula in EV and positions as well for continued growth in this exciting market. Regarding our balance sheet, we generated over $80 million in free cash flow and significantly reduced our net debt in the quarter. The debt reduction was driven by the full repayment of our $100 million revolver draw from March of last year. We continue to have ample liquidity, and our net leverage ratio is now near zero. The strength and flexibility of our balance sheet allows us to consider multiple paths to invest in the business in order to drive growth and ultimately shareholder return. In addition to the COVID-19 pandemic, we face the growing impact from a semiconductor shortage in the quarter. While the COVID-19 situation is improving, the on-going operating issues from it remain. In regard to the chip shorted situation, the impact of Methode in the third quarter was minimal. However, we do anticipate a financial impact in our fourth quarter and beyond as a result of the aforementioned issues as well as other potential supply chain disruptions. Moving to slide five, Methode had its best quarter of this fiscal year for booked awards. These awards continued to capitalize on key market trends like vehicle electrification, LED lighting and auto and sensors and e-bikes. The awards identified here represent a cross section of the business wins in the quarter and represent over $50 million in annual business. In vehicle electrification, we won awards for Busbar, power distribution and user interface programs. We continue to win programs with OEMs globally and auto commercial truck and even charging station applications. In non-EV LED lighting, we were awarded program for several auto applications. We also continued to participate in the growth of e-bikes, which utilizes our proprietary Magnetoelastic technology. Lastly, we won two sizeable awards for user interface programs with international automotive OEMs. For the first three quarters of the fiscal year, Methode has booked awards of over 150 million in potential annual sales. We continue to build on our foundation for organic growth. Regarding the anticipated roll off of our largest auto program, while we can't comment on a customer's timing, we are pleased that our strong new program bookings over the last several quarters have put us on a track in aggregate to replace the sales from that program. We're also pleased to project that our sales from any single customer is expected to drop below 25% from a high of approximately 50% four years ago. All while we continue to grow our top line. We are definitely making progress on reducing both customer and program concentration. Turning to slide six, I would like to elaborate further on our footprint in EVs. As I've shared with you before Methode has become uniquely qualified three prong solution provider for EVs. Those solutions include User Interface, LED Lighting and Power Distribution. The architecture of EV is generally divided into two parts, the “Top Hat” and the “Skateboard”. The Top Hat is essentially the body of the vehicle and varies from model to model. The Skateboard is the chassis or framework of the vehicle. As many of you know this type of vehicle architecture is a game changer with EVs as it can be standardized and leveraged across multiple models and platforms. On the Top Hat Methode offers its traditional vehicle solutions of User Interface and LED Lighting, along with some EV specific solutions, such as charging ports. These charging ports are fairly complex and include features such as actuators and lighting in addition to the power connection itself. On slide seven, we show Skateboard. This is where Methode leveraged it’s unique combination of auto grade manufacturing operations, our auto pedigree, and power distribution expertise to supply various Busbars, connectors and battery disconnect units to the EV OEMs. We're also gaining traction with sensor solutions for by-wire systems and battery monitoring. However, it is in the power distribution where the largest content growth opportunity lies. Historically, our participation with power products and internal combustion vehicles was minimal. In EVs, it is quickly growing as and has reached approximately half of our product sales for EV applications. Consequently, Methode has a clear opportunity to incrementally grow our content per vehicle with the transition to EVs. The additional content in EV could range from 20% to over 100% of our current content on an internal combustion vehicle. As I've said in the past, EV is a definite organic growth tailwind for Methode. To conclude, given the recent supply chain challenges and the on-going pandemic situation, I am extremely pleased that our strategy and our team were able to deliver at the high end of our previous guidance, generate significant free cash flow and win substantial new program awards in the quarter. At this point, I'll turn the call over to Ron, who will provide more detail on our third quarter financial results. Ron?

Thank you Don, and good morning everyone. Please turn to slide nine. Please note that the third quarter of fiscal year 2021 contains 13 work weeks, whereas the third quarter of fiscal year 20 get 14 workweeks. Third quarter sales were $295.3 million in fiscal year 2021 compared to $285.9 million in fiscal year 2020, an increase of $9.4 million or 3.3%. The year-over-year quarterly comparisons included a favorable foreign currency impact on sales of $9.7 million in the current quarter. On a weekly runway basis and excluding the foreign currency impact, net sales were up a solid 7.6% compared to the same quarter of fiscal year 2020. The increase was due in part to higher sales of electric and hybrid vehicle solutions. Third quarter net income decreased $9.3 million to $31.9 million or $0.83 per diluted share from $41.2 million or $1.09 per diluted share in the same period last year. In addition to one week less of production activity in the current fiscal quarter the decrease was primarily due to premium freight and factory inefficiencies resulted from supply chain disruptions due to COVID-19 and to a lesser extent, increased tariff expense and product sales mix. Also contributing to the decline was lower other income of $2.5 million and higher income tax expense of $1.8 million. Please turn to slide 10. Per quarter gross margins were lower in fiscal year 2021 as compared to fiscal year 2020, mainly due to premium freight and factory inefficiencies resulting from supply chain disruptions due to COVID-19 and the mentioned tariff expense and product sales mix. Fiscal year 2021 third quarter margins were 24.6% as compared to 27.7% in the third quarter of fiscal year 2020. The premium freight and other expenses resulting from inefficiencies in the supply chain that were experienced in the third quarter are expected to continue in the fourth quarter. However, we do not believe these issues are systemic and based on my knowledge at this time, will gradually be resolved in the fourth quarter with lesser impact to the first quarter of fiscal year 2022. Third quarter selling and administrative expenses as a percentage of sales decreased 50 basis points year-over-year to 11% compared to 11.5% in the fiscal year 2020 third quarter. The fiscal year 2021 third quarter percentage was attributable to lower compensation expense, lower travel expense and restructuring costs partially offset by higher stock based compensation expense. The decrease in compensation expense was primarily related to the benefit of restructuring actions taken in the first quarter of fiscal year 2021. While we anticipate an increase in the SG&A percentage on a go-forward basis due to a full year of amortization, on the restricted stock units, and more normal travel expense, we expect a future SG&A expense percentage to be more in line with our historical norms, which is still yield and efficient flow through from gross margins operating income. Regarding our restructuring activities, the third quarter expense was 700,000. And the year-to-date, third quarter expense was $8.3 million. The company currently expects an additional restructuring expense of 200,000 in the remainder of the fiscal year resulting from the previous quarter’s actions. The vast majority of the restructuring took place in the first half of the fiscal year. Please turn to slide 11. In addition to the gross margin and SG&A, items mentioned above two other non-operational items significantly impacted net income in the third quarter of fiscal year 2021 as compared to the comparable quarter last fiscal year. First, other income net was lower by $2.5 million, mainly due to lower government assistance between the comparable quarters. Second, income tax expense in the third quarter of fiscal year 2021 was $4.6 million, or 12.6% as compared to a tax expense of $2.8 million, or an effective tax rate of 6.4% in the third quarter of fiscal year 2020 The 12.6 effective tax rate for the quarter was less than the estimated tax rate due to the benefits of some tax planning enacted in the third quarter, which was retroactively applied to the first quarter of the current fiscal year. We expect to benefit from the third quarter tax planning in the current fourth quarter, which will result in an estimated fourth quarter effective tax rate of 15% down from the previously guided rate of 17%. Shifting to EBITDA, a non-GAAP financial measure, fiscal year 2021 third quarter EBITDA was $51.3 million versus $58.7 million in the same period last year. EBITDA was negatively impacted by the higher costs I previously noted. Please turn to slide 12. We reduced gross debt by $103 million in the third quarter, resulting from the full repayment of the $100 million precautionary draw we initiated in March 2020. Since our acquisition of Grakon in September 2018, we have reduced gross debt by $113 million. Net debt, a non-GAAP financial measures decreased by $108.9 billion in the third quarter of the fiscal year 2021 as compared to the fiscal year 2020 year end from $134.8 million to $25.9 million. We ended the quarter with $218.17 million in cash. Our debt, the trailing 12-month EBITDA ratio, which is used for our bank covenants is approximately 1.3. Our net debt to trailing 12-months EBITDA ratio was 0.1. Please turn to slide 13. Free cash flow, a non-GAAP financial measure which effective in fiscal year 2025 is defined as cash provided from operating activities minus CapEx. For the fiscal year 2021 third quarter, free cash flow was $82.8 million as compared to $6.7 million in the third quarter of fiscal 2020. The strong free cash flow performance was driven by an approximately $40 million favorable change in working capital in the quarter. While this level of working capital execution is not likely to be sustainable, especially as we navigate through supply chain challenges, we anticipate continuing our history of consistently generating predictable cash flows, which will allow for ample funding of future organic growth, inorganic growth and return of capital to the shareholders. In the third quarter of fiscal year 2021, we invested approximately $4.9 million in CapEx as compared to $8.1 million in the third quarter of fiscal year 2020. The lower third quarter CapEx was simply due to timing as opposed to any conscious effort to curtail CapEx. We approved CapEx during the quarter that was not reflected in the cash flow statement as the actual outlay for these approved expenditures will occur in future reporting periods. We have a strong balance sheet; it will continue utilizing it by continued investment in our businesses to grow them organically in the future. In addition, we continue to actively pursue opportunities for inorganic growth. Please start to slide 14. As Don mentioned is in his remarks, we are providing revenue and earnings per share guidance for the fourth quarter, which is subject to disruption at any time due to a variety of factors including direct and indirect impacts from the on-going COVID-19 pandemic situation, the semiconductor supply shortage and potential challenges from supply disruption resulting from the severe weather experienced in the U.S. in mid-February. The revenue range for the fourth quarter is between $270 million and $300 million. Diluted earnings per share ranges between $0.60 and $0.82. The wide range is due to the uncertainty from the supply chain disruption for semiconductors and other material on both Methode and its customers. Factors that could result in us moving towards the higher end of the sales rate include higher sales due to lesser supply disruption to us and our customers, which would result in higher demand for our products. Lesser disruption would also minimize the cost of sales and paying for premium freight factory inefficiencies and to a lesser extent tariffs and other logistic factors such as port congestion. Don that concludes my comments.

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

[Operator Instructions] And our first question is from Luke Junk. Your line is live.

Yes, good morning. Don wondering for the first question, if you could just talk about your current view of the chip shortage and what your customers are telling you at this point in here in early March. And curious within that if you think you're waiting to trucks and SUVs in the auto business should help to cushion the company to some extent the margin as we go to…

I’ll answer the last part first. I don't want to speak for the customer. But we do know that across the board customers are reallocating to the models that are selling for them. So we do benefit from that. No, but it's very difficult to project. How that will work out. We said we said in our third quarter that it was minimal, but we are seeing the effect of it and in our fourth quarter and our guidance clearly reflects that. So when we're being told it'll mitigate. It runs the gamut. The latest we heard is maybe the middle of the year. But we've also heard longer, as well. So it's very difficult from where we said to predict that and again, that's why we gave a wide guidance range.

Okay, understood. Second question I had is by my count, you show about a dozen or so EV product applications on slide six and seven. There are a couple of maybe two or three that you'd highlight as an emerging opportunity for the company beyond what you already know is your strengths in terms of Busbars and LED lighting is two key products for example.

Sure, one of the ones we like I mentioned in my prepared remarks are the charging ports. They've fairly complicated. There's actuators them and so there's coils in them, there's connectors, there's Class A surfaces. So we're we don't have any awards at the moment that I can announce but that is an area that we are pursuing. The other area where we take sensors and cameras and we do [Indiscernible] for one of the major EV company that has a camera in it, but we're also looking at putting cameras on class eight trucks as well. Not so much from electric standpoint, I guess but as you go into some of the other vehicles putting smaller delivery vehicles, putting external cameras on is another area that we are we're working on. From a Skateboard standpoint, the battery disconnect unit, we have some business with that. Now, those are fairly complicated. And then there's a power distribution unit as well, those are areas that those are high dollar content for the vehicles, and again, we're uniquely qualified to produce those. I think those will be the key areas.

Okay, great. Thank you for that. And then last question I had is if you could just remind us of your overall commercial vehicle exposure and industrial and more importantly, what your outlook for that businesses right now, based on the increase in order rates that we've seen, and as those rates start to recover.

We, we follow ACT. And we look at somewhat flat. I shouldn't say that, because it is increasing in our third and fourth quarter. But we see it mid next year, continuing to go up into 2023. I'm not sure if I would call it the peak. But I think that's where ACT has it. We tend to outpace ACT roll does have to see how strong the recovery is. And I would also point out that some of that is just catching up with demand.

Yes, we think to, that this, this trend going forward to will provide opportunity, for margin expansion into the next year. The whole segment, as we get into more vehicle electrification and the uptick in commercial vehicles, that's our highest margin segment. So to have more activity there should lift all boats so to speak. So that's a good thing that we watch very closely.

Great, thank you for that. I'll go ahead and leave it there.

Thank you.

[Operator Instructions] Your next question is coming from Ryan Sigdahl. Your line is live.

Good morning, guys. Thanks for taking our questions.

Good morning, Ryan.

Just want to dive in. You mentioned margin expansion next fiscal year, which is helpful directional commentary. This year, there's a lot of headwinds challenges, obviously, this year. But as we looking back maybe to fiscal 2020 EBITDA margins, were close to 20%. I guess, is that a reasonable baseline? You mentioned more content, higher margins, I guess directionally is that a good baseline for next year where you think you can do better than that? Or the reasons think it'll be worse?

That requires us to get into guidance next year. Let me see what we can say there. We've talked about margin expansion and too, because of class aids, and so if I were to look at the industrial margins, I would I would say we would benefit from that increase. Also, we have a better margin mix in some of the new products. Keep in mind, those won't launch in Q1 of fiscal 22. But the BDUs and the PDUs do carry much, much higher margins a little. I would expect from an industrial standpoint, we would see margin and expansion from that. Auto, that's that’s a tougher one. It really depends on chip shortages and what the flow of the flow through but what the actual demand is from the consumer. Right now we're benefiting from both consumer demands, which has been very good for trucks and SUVs. But there's also inventory replenishment of if you look at what the OEMs have in inventory there. They're the lowest I think I've seen in my time and in auto, so we're getting a double benefit from that. That'll take quite some time to probably with the shortages for the inventory to get back up to 90 days or 100 days old. Could that benefit us throughout our fiscal 2022? Yes, I just I don't want to sit here and say that for sure, we really need to see what happens with these with these shortages. And I know, you've got shortages, not just in semiconductors, but and we've and we have faced shortages, really, since the beginning of the pandemic. For the most part, we've been able to alleviate them, but they're, they're very real right now. And we're seeing them affect everybody's results around….

I agree with what Don saying and clearly all the headwinds from the shortages, and in that are the top line. And as you could see, through the results, they also have a double whammy effect and that they affect our operations as well, too. So a lot of what we're looking at next year will depend on that being satisfied and getting to a more normal run rate, and then I think we'd probably be in a better position to, to fine tune that answer.

And the other thing I would say, Ryan is, obviously we're very excited about our position in EVs. But we need to see how the programs materialized. Do they stay on track? Are they -- if the units are x? Is it you know, x plus? Or is it x negative, in the end, and no one has enough history on that to say for sure, so we're a little guarded, on what those volumes will be, you get on a get on a truck program for Ford or GM, you pretty much know what the volume is going to be. It's much more difficult in EV. Now, we're going to get some volume, because we're on the on the program, but we'll have to wait and see how that materializes.

And then, just on the chip shortage, and maybe I missed it earlier, did you quantify or could you quantify how much that impacted your Q4 guide? And then do you expect that to be resolved this quarter? Or do you think that'll linger into this next fiscal year?

I think it's going to linger into Q1 of next year. We have been told that perhaps by the mid calendar year that it may alleviate itself, but we've also had the caution that it may go on, we did not quantify it. There's a lot of moving pieces in the quarter. That's why we gave a large range. But I can tell you that. Let's go four or six weeks ago that our forecast for the fourth quarter was it was in excess of 300 million, which would have been a record quarter. So we're clearly being impacted in the fourth quarter, not so much the third quarter by chips, but we haven't. We haven't quantified exactly.

Last one for me. I've asked this previously, but a little more directly, maybe your net cash position, almost a net cash at this point based debt repayment, but from a capital allocation standpoint, your stock valuation relative to earnings it’s lagged peers for years, I guess you guys have focused on acquisitions, which have come at a fairly sizable premium to MEIs [Ph] valuation. Have you reconsidered a meaningful share buyback program versus more focused on acquisitions?

A very appropriate question. That is something that we are considering. We're now going to have over 200 million in cash, not likely to pay down much more data, very inexpensive debt, there's some debt in Europe, we may we may repay. So now, let me back up. We thought it was very, very important after doing the break on acquisition that we proved to the street that Methode has a discipline to achieve its synergies and more importantly, pay down debt. And we've accomplished that. And that for the last since the break on acquisition, that was priority one. Now where we are sitting today we're ahead of where we thought we would be largely because our teams that have very good job of taking classes out of the factories and dealing with tariffs and so on. So now we will turn our attention to where do we put that cast to use, do we do a stock buyback? That is that is certainly on our list. I won't, I won't give you a priority on it, but it is certainly something that we are we are considering. Now, having said that we will -- we always look at acquisitions. Grakon was I think at first, there was some concern about it. But it clearly has put us in good stead in the commercial vehicle market and the EV market. And some of the EV wins we had, or what will be commercial trucks, and particularly when you get into BDU and PDU. So, I'm not going to say that we're not going to do an acquisition. So I'm not going to give you the order, but I can tell you that a stock buyback is something that we would certainly consider.

Great, helpful color. Thanks. Good luck, guys.

Thank you.

There are no further questions from the lines at this time. I would now like to turn the call back to Don for closing remarks.

Yes, thank you very much. And we'll thank everyone for listening to us today and have a good, good rest of the day.

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