MEI - NYSE

Good morning, ladies and gentlemen, and welcome to the Methode Electronics First Quarter Fiscal 2023 Results Call. [Operator Instructions] It is now 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 Methode 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 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 statements 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. Thank you for joining us for our fiscal 2023 first quarter earnings conference call. I'm joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I will have opening comments, and then we will take your questions. Let’s begin with the highlights on Slide 4. Our sales for the quarter were $282 million, helping our sales by a $11 million with successful spot buy in premium freight cost recovery efforts. Working the opposite 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 through 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 and material, 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 we will see later, these awards were in a variety of applications, and once again, were 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% of our total sales in this fiscal year. In the quarter, we have positive free cash flow and purchased approximately $12 million of Methode stock. As at 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 Grakon acquisition. Moving to Slide 5, Methode 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 1 to 3 years from now. Also, while most of the dollar value of these words 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 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 Methode's core technologies, user interface, power, sensor, and lighting applications. Also notable is that they're in our two historically fastest growing regions, Europe and Asia. We also have solid awards for applications in motorsports, e-bikes and [indiscernible]. 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 is 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 Methode 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, I will 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 7. 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 in premium, freight cost recovery and unfavorable currency impact on sales of $14.2 million. Excluding the spot buy in 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 increase of $19.2 million or 9.8%. Net sales were negatively impacted by foreign currency exchange of $8.9 million, but benefited from stock 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 customers 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 HEV 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 $0.58 per diluted share from $29.1 million or $0.76 per diluted share in the same period last year. Sequentially from the fourth quarter of fiscal year '22. diluted earnings per share increased $0.15 per share from $0.43 to $0.58 per diluted share. Please turn to Slide 8. Fiscal year '23 first quarter gross margins were 21.9 percentage 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. [indiscernible] of these sales is removed, fiscal year '23 first quarter consolidated gross margins would have been 22.8%. Automotive segment gross margins decreased 33.7% [ph] in the quarter of fiscal year '23, down from the 36.3% gross margins in the first quarter '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 costs inflation, increased freight and logistics costs and 25% was related to inventory items, unfavorable absorption due to China lock downs 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 and commercial vehicle or EV production levels, we anticipate opportunity for modest improvement in the Industrial segment margin for the remainder of the current fiscal year. Fiscal year '23 first quarter selling and administrative expenses as a percentage of sales was 12.5% as compared to 11.4% in the first quarter of fiscal year '22, mainly due to increased wages, and other general and 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 9. 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 cost due to material cost inflation spot buys and premium rate, 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 Grakon in September of 2018, we have reduced gross debt by $150 million. 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 months EBITDA ratio, which is used for bank covenants is approximately 1.3, well below our covenants threshold of 3.5. Our net debt to trailing 12 months 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 the 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 16, 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 mega trend. 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 turn 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 the related impact in 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 million to $1,210 million. The anticipated growth at the midpoint of our range considers the full year impact of a large automotive program roll off, which had sales in fiscal '22 in excess of $100 million. The diluted earnings per share range is also unchanged at $2.70 to $3.10 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 million and $50 million as we expand our capabilities to support our growth in EV sales and strategically positioned our global footprint to support production of our significantly increased order backlog that we have built over the last 2 years. Estimated depreciation and amortization expense remains between $54 million 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 3-year organic compounded annual growth rate of approximately 6%. This CAGR continuously 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. Ellie [ph], we are ready to take questions.

[Operator Instructions] Our first question is coming from Luke Junk with Baird. Sir, please go ahead.

Questions. To start -- hoping we could start with the automotive business, specifically, I was hoping you could help us unpack the two factors you said behind continued to do 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 of the program, what we've anticipated for quite some time, I don't put a whole lot of weight to that. That we -- several years ago, we booked EV programs that we saw from revenue that replace that. The impact, even though we did recover some of our costs during the quarter was from an ongoing supply chain issues both inflation -- inflation, wage inflation and logistics. So if those didn't exist in the quarter, we would, I don't think we'd be talking about the roll off of public programs. So those are, I think, mutually exclusive. Now, what impacted auto is the macroeconomic conditions in Europe, which is a high -- higher margin territory for us than in the United States, so that the combination of the logistics and inflation as well as European sales, and mix contributes to that. Ron, is there …?

Yes, I think we'll recover -- we anticipate recovering what was lost "in China", we anticipate recovering that the rest of the year. And as the stickiness as 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 clearly starting to see some improvement in earnings versus where the fourth quarter shakeout from here that of course is going to need to continue back in the envelope. If I do the math, take the midpoint of guidance and what you reported this year, then, or this quarter, I should say, that was about $0.77 per quarter and 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 would say, somebody's going to run a tautology, say the rest of it.

Yes, look, 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 will have bringing to launch. You'll see, we anticipate progression throughout the year in terms of EPS growth.

But will give quarterly guidance, but we didn't say math and achieving that, on average per quarter is achievable. So we're confident that going forward, being short of another lockdown in China.

Okay. Thanks for that. And then just one last question, if I can sneak 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 year as we look over the rest of fiscal 2023? Thank you.

Sure. If I look quarter-over-quarter, very strong quarter in the fourth quarter, $1.6 million and this quarter was $0.7 million [ph]. I don't read too much into that the fourth quarter had a very large order, and it actually have large order over $0.5 million and then a kind of a mid-size order. And that's really dictated by when the evaluations are done by the hospital, they had 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's -- that was weaker again. I think what the bear is experiencing was the long-term effect of COVID on the revaluation. So it kind of makes the order flow a little lumpy, but to your question, what are we expecting in the $4 million to $5 million range, we get the evaluations done. I’ve mentioned before we almost always get business after an evaluation. So for whatever reason, they've all been successful. So I'm anticipating that the pace for the bear will pick up. And to the last part of your question. We remain confident in that business. The list of customers continues to grow. So we understand the issues that have with evaluation, but we still remain confident in the business.

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

Thank you.

[Operator Instructions] Our next question is coming from John Franzreb with Sidoti. Please go ahead.

Good morning, guys and thanks for taking the questions.

Good morning.

I would 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 year as well as relative to the first quarter?

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

Hey, John, I -- with the comfort in that, the business continues to grow. And it was impacted by logistics and inflation. But not quite as much as all of 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 it's our commercial business is quite strong, and the customers continued to [indiscernible] business.

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 prepared remarks, as long as inflation continues, we're going to be behind the [indiscernible] in any given quarter. You're recovering from maybe the previous two quarters, but now you've got another increase, 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 for this question. [Indiscernible] lockdown in China at Chengdu [ph]. 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 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 [indiscernible] that will help us -- that will have an effect on us. To what degree we do have inventory, we have a product on the water, unfortunately, and that contributes to inventory. But that is the biggest factor even more so than maybe the macroeconomic conditions in Europe.

And regarding the easy target, do you need China to come back? Either way can hit at your [indiscernible]?

I think we can. If your question is if it stays status quo, can we hit the target? And our projections are yes, again. Let me repeat myself [indiscernible] dramatic, 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. Now, 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 [indiscernible] debt, if you pay that down, 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 the -- 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 the world economy. That'll 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 their 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.

Ellie, thank you. Thanks everybody for listening and wish everybody a safe and enjoyable Labor Day weekend. Good bye.