Methode Electronics Q2 2024 Earnings Call Transcript

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December 7, 2023

There are 7 speakers on the call.

Operator

Greetings, and welcome to the Methode Electronics Second Quarter Fiscal 20 24 Results Call. At this time, all participants are in a listen only mode and a question and answer session will follow the formal presentation. 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.

Operator

Sir, you may begin.

Speaker 1

Thank you, operator. Good morning, and welcome to Mezzo Electronics' fiscal 2024 which can be viewed on the webcast of this call or found at mezzo.com on the Investors page. This conference call contains certain forward looking statements, which reflects 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 this statement to actual results or changes in Methode's expectations On a quarterly basis or otherwise, the forward looking statements in this conference call can follow a number of risks and uncertainties.

Speaker 1

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 ks and 10 Q reports. At this time, I'd like to turn the call over to Mr. Don Duda, President and Chief Executive Officer.

Speaker 2

Thank you, Rob, and good morning, everyone. Thank you for joining us for our fiscal 2024 Second Quarter Earnings Conference Call. I'm joined today by Ron Zumas, 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.

Speaker 2

Our sales for the quarter were a solid $288,000,000 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 Moorink 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 $57,000,000 related to the North American Auto and European Auto reporting units.

Speaker 2

Ron will go through the financial mechanics later in the call, But the summary of the situation is that 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 continue to experience operational inefficiencies in our North American auto operations that manifested in the Q1. As you may recall, they were caused primarily by salary 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 spot purchases and premium freight and labor. In a lean manufacturing environment, Disruptions like this can ultimately generate significant cost to address material shortages and maintain customer delivery integrity.

Speaker 2

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.

Speaker 2

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.

Speaker 2

We had a modest quarter with over $20,000,000 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 OEM's expectations.

Speaker 2

Turning back to EV activity. Sales in the quarter were 19% of our consolidated total. In regards to awards, We won over $15,000,000 in annual EV program awards in the quarter. For fiscal 2024, Sales activities will be strong, but will 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 was driven by an investment in working capital to support our sales and launches.

Speaker 2

While our debt and consequently 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, Acquiring just under $8,000,000 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 2024, but will be positive in fiscal 2025. Turning to Slide 5.

Speaker 2

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 2024 and into fiscal 2025, we have a definitive path forward and would like to clearly articulate.

Speaker 2

Our fiscal 2024 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 are addressing via pricing And increased cost improvement initiatives such as vendor price reduction and value engineering. As such, Fiscal 2024 is a pivotal year of investment and transition with the objective of a clean start to fiscal 2025. As mentioned, we are launching over 20 new programs this year, which requires significant investment and resources.

Speaker 2

That ongoing investment is in items like facility preparation, product qualification, staffing and training expenses, along with the additional costs required to Our operational issues this year have required us to lower fiscal 2024 guidance. For our Q3, we now expect a modest improvement over the Q2. We then expect further improvement in the Q4. Turning to fiscal 2025. Our outlook continues to be positive, supported by multiple years of strong awards.

Speaker 2

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 3 years.

Speaker 2

As such, we've reduced our guidance for fiscal 2025, mainly due to the EV market trends. To illustrate, we've had 1 major EV program get partially delayed from fiscal 2025 to fiscal 2026. To summarize, we are decisively making the investments in fiscal 2024 to ensure profitable growth in fiscal 2025. 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

Speaker 3

Turning to Slide 6. In order to give

Speaker 2

you a more granular picture of our sales guidance, We've updated the bridge that we provided last Q4 for our guidance walk from fiscal 2023 to 2025. 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 2025 have been reduced by approximately $70,000,000 due to customer delays into fiscal 'twenty six. Together, these drivers have caused us to lower our fiscal 'twenty five guidance by $100,000,000 at the midpoint. At this point, I'll turn

Speaker 4

the call over to Ron, who will

Speaker 2

provide more details on our Q2 financial results as well as more details On our outlook.

Speaker 3

Thank you, Don, and good morning, everyone. Please turn to Slide 8. 2nd quarter net sales were $288,000,000 compared to $315,900,000 in fiscal 2023, a decrease of 9%. This quarter sales included $20,900,000 from the Nordic Lights acquisition and $3,500,000 from favorable foreign currency translation. Excluding Nordic Lights and foreign currency sales decreased by 16.6%.

Speaker 3

The quarter saw the continuation of 2 key automotive program roll offs, 1 in North America and 1 in Asia. We also had a difficult comp in Asia as in the prior year Asia benefited from sales that were delayed from the Q1 to the 2nd 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. 2nd quarter loss from operations was $51,300,000 down from $32,800,000 of income in fiscal The major factor in the decrease was a goodwill impairment charge of $56,500,000 At the end of the Q2, 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 2 reporting units and determined that the current fair value of the goodwill was less than the carrying value resulting in an impairment at 2 of our automotive reporting units. Income was also down due to lower sales volume and the ongoing operational inefficiencies, which drove higher premium freight and labor expenses.

Speaker 3

Adjusting for the goodwill impairment of $56,500,000 restructuring costs mainly related to the exit from Dabir of $600,000 and costs related to the Nordic Lights acquisition of $200,000 our non GAAP adjusted income from operations was $6,000,000 Please turn to Slide 9. 2nd 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 costs 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

Speaker 5

to $0.06 per share.

Speaker 3

Shifting to EBITDA, a non GAAP financial measure, 2nd quarter EBITDA was a negative $36,700,000 a positive $46,100,000 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 $600,000 loss on sale of assets of 0 point $1,000,000 and purchase accounting adjustments related to inventory of $200,000 our adjusted EBITDA decreased 55% to $21,200,000 Please turn to Slide 10. We increased gross debt by $25,200,000 in the quarter, Mainly due to working capital investments and higher CapEx, both to support sales and new program launches.

Speaker 3

We ended the quarter with $122,500,000 in cash, down $34,500,000 from the end of the last fiscal year. Net debt, a non GAAP financial measure, increased by $59,700,000 to $209,500,000 for the quarter, Up from $148,900,000 at the end of fiscal 2023. Again, the main drivers of the increase were an increase in working capital and higher CapEx. Please turn to Slide 11. 2nd quarter net cash from operating activities was an outflow of 0 point $6,000,000 as compared to an inflow of $15,400,000 in fiscal 2023.

Speaker 3

The decrease of $16,000,000 was primarily due to lower net income in 2nd quarter capital expenditure was $10,700,000 as compared to $8,400,000 in fiscal 2023, An increase of $2,300,000 The increase was mainly a function of investments to support new program launches and was keeping in line with our guidance. 2nd quarter free cash flow, a non GAAP financial measure, was a negative $11,300,000 as compared to a positive $7,000,000 in fiscal 2023, A decrease of $18,300,000 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 Q3 should be similar

Speaker 2

to our Q2.

Speaker 3

However, the operational efficiencies experienced in the 2nd quarter will carry over to the 3rd quarter and likely into the 4th quarter. This is longer than we had previously estimated. As a result, the expected adjusted diluted earnings per share in the 3rd quarter We'll only be modestly higher than the Q2. Turning to the full year, the expected net sales range for fiscal 2024 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 per share.

Speaker 3

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 $0.08 This fiscal 2024 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 $60,000,000 to $70,000,000 for the full fiscal year And assumes depreciation and amortization of $55,000,000 to $60,000,000 There have been no changes to any of those three items. Looking further ahead of fiscal 2025, the expected net sales range is now 1,150,000,000

Speaker 1

to

Speaker 3

$1,250,000,000 down from $1,250,000,000 to $1,350,000,000 The midpoint of the new range is lower by $100,000,000 primarily due to the EV customer program delays into fiscal 2026. The expected range of income from operations as a percentage of net sales in fiscal 2025 is now 6% to 8%, down from 11% to 12%. This reduction is mainly due to the $100,000,000 net sales reduction And its impact on overhead absorption. It still represents a significant improvement over fiscal 2024 and is on par with what Metho delivered for operating margin in fiscal 2023. The fiscal 2025 income tax rate is expected to be between 20% 22% With no discrete tax benefits or expenses.

Speaker 3

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.

Speaker 2

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

Operator

Thank you, sir. At this time, we will be conducting a question and answer 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 Yunck with Baird.

Operator

Your line is live.

Speaker 6

Good morning. Thanks for taking the questions.

Speaker 2

Good morning, Andrew. Good

Speaker 6

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 that 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 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 expectations to the new, especially where maybe you were overly optimistic previously?

Speaker 4

Sure. As I said,

Speaker 2

I was overly optimistic. There

Speaker 4

it is taking us longer to go through The various, routings and, part numbers and make corrective actions,

Speaker 2

to give you more color on

Speaker 4

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 as

Speaker 3

normally we do when we try

Speaker 4

to lean out Our operations, we brought inventory down and one of the analogies that the lean experts sometimes use is the pond. Then you lower the pond, you find the rocks, and 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 Dongguang, China that's shipped to Monterey. Engineering changes weren't recorded properly.

Speaker 4

And we said, a lot of it was due to solid personal turnover that there was a certain amount of knowledge there 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

Speaker 2

the system at 2

Speaker 4

weeks when it probably should have been closer to 2 months. Also there we saw a changing and 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 Stress on the system. So, and Brian, is there anything that

Speaker 3

Not from an operational perspective, I think you

Speaker 4

And there was probably a lag On some of the invoicing, you don't get invoiced next week for premium shipments and there's probably some of that occurred In the Q1, they carried over in the Q2. Again, all fixable. It's as we underestimated amount of time.

Speaker 6

And then just to maybe put a finer point on that, Don. What I'm hearing is it's 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?

Speaker 4

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

Speaker 2

Got it. That's helpful.

Speaker 6

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 2025 guidance? You mentioned The program that had slipped partially from 2025 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

Speaker 2

this new fiscal '25 guidance. Thank you.

Speaker 4

We had 2 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 and forecast along with LMC and IHS and what program delays we knew about. And that really is what contributed to the change. We're 4 months plus out from 25, and I'm sure there'll be additional revisions as we get closer to giving guidance. Some of that Could go up. One of the reasons where we still have $12.50 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.

Speaker 4

So in general, it's just we did a deep dive into the forecast and adjust the guidance I don't from my standpoint, is the EV market So collapsing or is there a major problem? No. I don't know if I want to use the word over or the phrase over exuberance, but there is probably Some of that in the forecasting by the market, but I fully believe that 'twenty five will be a good year for us and 'twenty six will be a better year. But we'll going to see some Fluctuations in forecast until the industry really sorts out what's the really the adoption level.

Speaker 6

Got it. I'll leave it there. Thanks, Dan.

Speaker 2

Thank you.

Speaker 5

Thank

Operator

you. Our next question is coming from Gary Prestopino with Barrington Research. Your line is live.

Speaker 5

Hi, good morning all. Good morning, Jerry. 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?

Speaker 4

On our largest program, I want to say it's probably 80, 20, 20 or something in the last

Speaker 2

mile, maybe slightly higher than that. I don't know what we revised that too, but it's probably in

Speaker 4

that range. I've said before, I like the last mile vehicle. 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.

Speaker 5

But you say it's about 80, 20 passenger last mile?

Speaker 2

Yes.

Speaker 5

Okay. That's fine. Thank you. And then just getting into this write down again, Exactly. Could you just briefly explain what happened?

Speaker 5

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?

Speaker 3

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, we run the projections and all that valuation performed and Came up with the impairment amounts on 2 of those reporting units.

Speaker 5

Okay.

Speaker 3

We do test for this annually each year. About whether it's triggering events in between the annual Impairment tests, we do test in between the annual ones and this is what happened in this particular quarter.

Speaker 5

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?

Speaker 3

Correct. That was the 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 If it's 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 2 businesses In excess of $56,000,000

Speaker 5

Doing an impairment like this on a longer or 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

Speaker 3

ahead. First of all, and then, Don, you can interject. It's more about the impairment resulted from more about Acquisitions that occurred in the past

Speaker 5

and

Speaker 3

the 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, we're doing a lot of investment in CapEx for the expansion to support our new program. So that part of it is forward looking. The impairment and the goodwill that was created was backward looking.

Operator

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.

Speaker 2

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

Operator

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

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Key Takeaways

  • Methode Electronics reported Q2 sales of $288 million, down 9% year-over-year, primarily due to auto program roll-offs, China COVID-delayed orders, e-bike market softness and the UAW strike, partially offset by the Nordic Lights acquisition.
  • The company took a $57 million non-cash goodwill impairment in its North American and European auto units after operational inefficiencies—driven by personnel turnover, vendor issues and planning deficiencies—led to premium freight, unreimbursed spot buys and inventory shortages.
  • Integration of the Nordic Lights acquisition is complete and performing in line with expectations, and Methode resumed its share buyback program during the quarter, repurchasing just under $8 million of shares.
  • Electric vehicle activity represented 19% of consolidated Q2 sales, with over $15 million in new annual EV awards, though fiscal 2025 sales guidance was reduced by $100 million at the midpoint due to customer program delays and shifting take-rate projections.
  • Fiscal 2024 sales guidance remains at $1.14 billion to $1.18 billion, but EPS was revised to a loss of $1.40–$1.14 per share (adjusted $0.24–$0.50), while fiscal 2025 sales are expected at $1.15 billion to $1.25 billion with operating margins of 6–8%.
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