Methode Electronics, Inc. (NYSE:MEI) Q2 2024 Earnings Call Transcript

Methode Electronics, Inc. (NYSE:MEI) Q2 2024 Earnings Call Transcript December 7, 2023

Methode Electronics, Inc. misses on earnings expectations. Reported EPS is $ EPS, expectations were $0.09.

Operator: Greetings and welcome to the Methode Electronics Second Quarter Fiscal 2024 Results Call. [Operator Instructions] 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.

Robert Cherry: Thank you, operator. Good morning and welcome to Methode 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 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.

Don Duda: Thank you, Rob and good morning everyone. Thank you for joining us for fiscal 2024 second quarter earnings conference call. I am 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 on Slide 4. 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 Nordic 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 with the recent operating profit 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 continued 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 salaried personnel 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 spa purchases and premium freight and labor. In our lean manufacturing environment, disruptions like this can ultimately generate significant cost 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 Methode’s 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-term opportunities to win business due to smaller busbar competitors who are not performing to the OEMs expectations.

Turning back to EV activity. Sales in the quarter were 19% of our consolidated total. In regards to awards, we won over $50 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 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 support our sales and launches. While our debt and consequently, our leverage has increased, it is still at a reasonable level. As such, we are 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 according 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 5, 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 repurchase program. Looking at the remainder of fiscal ‘24 and into fiscal ‘25, we had a definitive path forward and we will 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 have experienced substantial price cost pressure during the year which we are 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 are launching over 20 new programs this year, which requires significant investment and resources. That ongoing investment is in items like facility preparation, product qualification 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 EVs 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 3 years. As such, we have reduced our guidance for fiscal 2025 mainly due to the EV market trends. To illustrate we have had one major EV program get partially delayed from fiscal ‘25 to fiscal ‘26. To summarize, we are decisively making good 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 the strategic direction that we have taken into lighting and power solutions to grow the business. Turning to Slide 6, in order to give you a more granular picture of our sales guidance, we have 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, probably 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. And at this point, I will turn the call over to Ron who will provide more details on our second quarter financial results as well as more details on our outlook.

Ron Tsoumas: Thank you, Don and good morning everyone. Please turn to Slide 8. 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, foreign currency sales decreased by 16.6%. 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 due to lower sales volume and the ongoing operational efficiencies, which drove higher premium freight and labor expenses.

Adjusted for the goodwill impairment of $56.5 million, restructuring costs mainly related to the exit from Dabir of $0.6 million and cost related to the Nordic Lights acquisition of $0.2 million, our non-GAAP adjusted income from operations was $6 million. Please turn to Slide 9. Second quarter diluted earnings per share decreased to a negative $1.55 from a positive $0.75 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 cost of $0.01, a loss on sale of assets of $0.01, and purchase accounting adjustments related to inventory of $0.01, our non-GAAP adjusted diluted EPS decreased to $0.06 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 cost 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% 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 reduced – to 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 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 net sales range for fiscal ‘24 is still $1.140 billion to $1.180 billion 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 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 Dabir 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 million to $70 million for the full fiscal year and assumes depreciation and amortization of $55 million to $60 million.

There have been no changes to any of those three items. Looking further ahead at fiscal ‘25, the expected net sales range is now $1.150 billion to $1.250 billion, down from $1.250 billion to $1.350 billion. The midpoint of the new range is lower by $100 million 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%, down from 11% to 12%. 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 Methode delivered for operating margin in fiscal ‘23. The fiscal ‘25 income tax rate is expected to be between 20% and 22%, 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 Two minimum global tax initiative. Don, that concludes my comments.

Don Duda: Thank you very much. Ali, we are ready to take questions.

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Q&A Session

Operator: Thank you, sir. [Operator Instructions] Our first question is coming from Luke Junk with Baird. Your line is live.

Luke Junk: Good morning. Thanks for taking the questions.

Don Duda: Good morning, Junk.

Luke Junk: Good morning. Don, hoping to start with the – 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 or 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 may be you were overly optimistic previously? Thanks.

Don Duda: Sure. As I said, I was overly optimistic. There 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 – as normally we do when we try to lean out our operations, we brought inventory down. And one of the analogy is that the lean experts sometimes uses the ponds and you lower the ponds you find rocks, but we found boulders. And it took us much longer, it is taking little longer to correct. They are all, as I have said all fixable. But it’s a mismatch between our various systems. We do manufacture products in Dongguan, China and that’s shipped to Monterrey.

Engineering changes weren’t recorded properly, and we have said a lot of that was due to salary, personnel turnover that there was a certain amount of knowledge here that probably got lost at the end of COVID. So, it’s really dealing with routings, MRP and lead time. And we had some lead times in the system at two weeks, when it probably should have been closed in two months. Also there, we saw changing, I don’t know if this is a COVID leftover, but we are 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, and Ron, is there anything that…

Ron Tsoumas: From an operational perspective, I think you…

Don Duda: There was probably a lag on some of the invoicing you don’t get invoiced next week for premium shipments. And there is probably some of that occur in the first quarter, the carryover in the second quarter. Again, all fixable, it’s as we underestimated amount of time.

Luke Junk: And then just maybe put a finer point on that Don, what I am hearing is it’s more of these actions are continuing. But in terms of the corrective actions, it doesn’t sound like you are necessarily leaning to put new actions into place or it’s more a scope issue, not that there is kind of new problems that you found, is that right?

Don Duda: Yes. That’s correct. It’s really a time factor that we uncovered nothing new that would have caused us to change anything and change any of our actions.

Luke Junk: 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 am 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 is any anecdotes on that latter piece in terms of take rates that you can share. Just help us understand the level of conservatism that’s in this new fiscal ‘25 guidance. Thank you.

Don Duda: We had two of our long-term Vice Presidents do a deep dive into our forecasting. And an overlay that with various expectations that we are hearing from our customers are forecast along with LMC and IHS and what program delays we knew about, and that really was what contributed to the change. We are four months plus out from ‘25. And I am sure there will be additional revisions as we get closer to giving guidance. Some of that could go up. One of the reasons where we still have 12-15 as the upside is there are some opportunities that are surfacing and 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.

I don’t – from my standpoint, is the EV market collapsing, or is there a major problem now, I don’t know if I want to use the word over or the freight over-exuberance. But there is probably some of that in the forecasting by the market. But I fully believe that ‘25 will be a good year for us and ‘26 will be a better year, But we are going to see some fluctuations in forecasts until the industry really sorts out what’s the really the adoption level.

Luke Junk: Got it. I will leave it there. Thanks Don.

Don Duda: Thank you.

Operator: [Operator Instructions] Our next question is coming from Gary Prestopino with Barrington Research. Your line is live.

Gary Prestopino: Hi. Good morning all.

Don Duda: Hi Garry.

Gary Prestopino: Could you refresh my memory? Are your EV programs – what is the split there between commercial vehicles, like last mile delivery vehicles and regular passenger cars?

Don Duda: Our largest program, I want to say it’s probably 80-20, 20 or something the last mile, maybe slightly higher than that. I don’t know when we revised that two. But it’s still probably in that range. I have said before, I like the last mile vehicle that they are definitely cost effective for the Amazons of the world. So, we will place emphasis on that and our largest program, part of that is last mile.

Gary Prestopino: But you say it’s about 80-20 passenger last mile.

Don Duda: Yes.