Methode Electronics Inc.  (NYSE: MEI) Q4 2020 Earnings Call Transcript

Methode Electronics Inc.  (MEI) Q4 2020 earnings call dated June 30, 2020

Corporate Participants:

Donald W. Duda — Director, President and Chief Executive Officer

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

Analysts:

Ryan Sigdahl — Craig-Hallum — Analyst

Matt Sheerin — Stifel — Analyst

Presentation:

Operator

Good day, ladies and gentlemen, and welcome to the Methode Electronics Fourth Quarter Fiscal 2020 Results Call. [Operator Instructions].

At this time, it’s my pleasure to turn the floor over to Mr. Rob Cherry, Vice President of Investor Relations. Sir, the floor is yours. Thank you, operator. Good morning and welcome to Methode Electronics’ fiscal year 2020 fourth quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2020 Fourth Quarter and Full Year Financial Results, which can be viewed on the webcast of this call, or found at methode.com in the Investors section. 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 call involve a number of risks and uncertainties. The factors that could cause actual results to differ materially from expectations are detailed in Methode’s filings with this Securities and Exchange Commission, such as our annual and quarterly reports. Such factors may include, without limitation, the following; impact from pandemics, such as the COVID-19 pandemic; dependence on the automotive, appliance, commercial vehicle, computer and communications industries. Dependence on a small number of large customers, including two large automotive customers. International trade disputes, resulting in tariffs and our ability to mitigate tariffs; timing, quality and cost of new program launches; ability to withstand price pressure, including pricing reductions; failure to attract and retain qualified personnel; ability to successfully market and sell Dabir surface products; currency fluctuations; customary risks related to conducting global operations; costs associated with environmental health and safety regulations; ability to withstand business interruptions; recognition of goodwill and long-lived asset impairment charges; ability to successfully benefit from acquisitions and divestitures; investment programs, prior to the recognition of revenue, dependence on the availability and price of materials; dependence on our supply chain; judgments related to accounting for tax tax positions; income tax rate fluctuations; ability to keep pace with rapid technological changes; impacts to our information technology systems; ability to avoid design or manufacturing defects; costs associated with reorganization activities; ability to compete effectively; ability to protect our intellectual property; success of Grakon and/or our ability to implement and profit from new applications of the acquired technology; significant adjustments to expense, related to our performance-based stock awards in our long-term incentive plan; ability to manage our debt levels and any restrictions thereunder; and impact to interest expense from the replacement or modification of LIBOR. At this time, I’d like to turn the call over to Mr. Don Duda, President and Chief Executive Officer.

Donald W. Duda — Director, President and Chief Executive Officer

Thank you, Rob, and welcome to Methode. Good morning everyone and thank you for joining us today for our fiscal 2020 fourth quarter and full year financial results conference call. I’m joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I have opening comments and afterwards, we will take your questions.

First, I would like to note that our fiscal 2020 accounting period included 53 weeks versus 52 weeks for fiscal 2019. Also, the fiscal 2020 results include 12 months of Grakon activity, as compared to 7.5 months of Grakon activity in the fiscal 2019 results. As you can see on slide 4. I would also like to draw your attention to our refreshed Corporate and Investor Relations web sites. We believe, both provide an improved user experience, as well as better depth and visibility of information.

Please turn to slide 5; Methode’s full-year revenue increased 2.4%. Our net income increased 34.7% and our diluted earnings per share increased 34.2% for the fiscal year ended May 2nd of 2020. All three financial measures were a record for Methode. The cost reduction and operational efficiency initiatives that we implemented in fiscal 2019, provided the savings we expected in fiscal 2020.

On a non-GAAP basis, our adjusted net income increased 5.7% and adjusted diluted earnings per share was up 5.4%. These adjusted measures exclude expenses for initiatives to reduce overall costs and improve operational profitability, acquisition related costs, long-term incentive plan accrual adjustments, and the transition tax benefits from U.S. tax reform in the applicable periods. As you can see, on both a GAAP and adjusted basis, it was a commendable performance for the year that drove record free cash flow, increasing over 48% for fiscal 2019.

On slide 6, is our full year revenue bridge, which includes the benefit of an extra 4.5 months of great connectivity and $76 million in sales from new program launches. Speaking of Grakon, I’m happy to report that we completed the integration and are pleased that the acquisition delivered the results we expected. Adversely affecting the year, was the UAW labor strike that occurred on our second quarter and the impact from COVID-19 in the fourth quarter. After the negative impact from foreign currency exchange, the full year revenue performance was still up approximately $24 million to a record level.

In regard to COVID-19, our focus continues to be on the health and safety of our employees who have shown incredible dedication to Methode and our customers in light of extraordinary circumstances across the globe. Given this health crisis and business disruption, we have implemented measures to manage costs, preserve liquidity and most importantly, address employee safety. These safety measures include enhanced cleaning and disinfection procedures at our facilities, but promotion of social distancing, a majority of office staff working from home, and stringent factory and office protocols for proactive COVID-19 mitigation. Methode was able to apply the early lessons learned in its Asian operations, developing actions and protocols to deal with COVID-19 and leverage them in our plants and facilities in rest of the world, as the pandemic spread.

As a result of these mitigations and given the essential nature of some of our businesses, all of our facilities remained open to a certain degree and operated at levels commensurate with customer orders. In fiscal 2021, we will continue to see significant headwinds, especially in the first quarter from the COVID-19 pandemic. However, I want to stress that we will continue to invest in our businesses for the long term.

Moving to slide 7; during the fourth quarter, new awards in the Automotive and Industrial segments continue to capitalize in important trends, including vehicle electrification and the incorporation of LED lighting and sensors to augment safety. We are very pleased that we booked over $36 million in new annual business in the fourth quarter, with our total fiscal 2020 exceeding $141 million. In the quarter, Methode was awarded several key programs tied to our ongoing strategy. In electric vehicles, we were awarded programs for Busbars and AC power connectors, totaling $10 million annually. In Sensors, we were awarded a program in China for e-bikes for $2.3 million annually. In vehicle exteriors, we were awarded an initial integrated tailgate module program for Japanese auto OEM for $1.7 million. As we have successfully accomplished in the past, Methode will continue to evolve its business, with new technology and products, such as our unique sensors, LED lighting and Power Solutions for electric vehicles, and we will develop innovative products for new applications, like remote controls for industrial drones, which is an up and coming market for our Hetronic business.

In the Medical segment, our efforts to grow Dabir product line in the quarter were hampered by the postponement of elective surgeries due to COVID-19. When the pandemic subsides and hospitals return to normal, we believe that business will return to a growth trajectory.

Looking forward, we are not providing annual guidance for fiscal 2021, due to the ongoing market uncertainty and the resulting lack of customer demand visibility, due to the COVID-19 pandemic, which includes our fiscal first quarter. Most auto and commercial vehicle production that was shut down before the beginning of our fiscal 2021 first quarter until approximately mid-June or roughly the first half of the quarter. When production did resume, the demand was irregular, and we continue to see volatility and forecast as of today. As our June [Phonetic] quarterly guidance we were to get would be heavily weighted to July, and would carry a range of uncertainty, that would not provide meaningful insight.

While we are not providing any guidance at this time, we do intend to provide partial year guidance at a future date, as soon as demand schedules stabilize and we are confident with our customers’ forecasts.

As part of our continuous improvement strategy, in an effort to manage cost and cash, Methode is taking further actions to consolidate operations and further streamline our organization, in order to improve efficiencies and set the stage for continued growth. These actions will allow us to further improve on our S&A as a percent of the sales, and be in a better position to capitalize on opportunities as they present themselves.

To conclude, given the current global macroeconomic situation and the significant headwinds faced by Methode throughout this past fiscal year. I am extremely pleased that our strategy and team were able to deliver record revenue and income and generate record free cash flow. That said, our focus is now turned to continuing to navigate COVID-19, while it’s executing our long-term strategy as we enter a new fiscal year.

At this point, I’ll turn the call over to Ron, who will provide more detail on our financial results. Ron?

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

Thank you, Don, and good morning everyone. Please turn to slide 8; fourth quarter sales decreased 20.8% or $55.4 million to $210.6 million in fiscal ’20 from $266 million in fiscal ’19. Sales in the fourth quarter were negatively impacted by COVID-19, especially in the mid-to-late March and April timeframes. These production shutdowns, most of which impacted the Automotive and Industrial segments, continued through the end of first fiscal fourth quarter and had a negative impact of approximately $85 million on net sales. Foreign currency exchange continued to be a headwind, as both the euro and renminbi exchange rates were weaker than the prior year, reducing net sales in the quarter by $3.5 million.

On a GAAP basis. fourth quarter net income increased $7.5 million to $30.1 million or $0.79 per share, from $22.6 million or $0.60 per share in the same period last year. Fourth quarter GAAP net income benefited from the adjustment of long-term incentive accruals of $6.5 million and higher other income of $5.5 million, primarily due to higher international government grants, inclusive of COVID-19 assistance.

In addition, we realized benefits from initiatives to reduce costs and improve profitability taken in fiscal 2019, which included lower expense for those actions in the current fiscal year, versus last fiscal year. Adjusted net income, a non-GAAP financial measure was $25.4 million or $0.67 per diluted share, as compared to $23.5 million or $0.62 per diluted share in the same quarter of fiscal 2019. Adjusted net income excluded expenses for initiatives to reduce overall costs and improve operational profitability, acquisition related costs and long-term incentive plan accrual adjustments in the applicable periods.

Moving to gross margins on slide 9. Fourth quarter GAAP gross margins were higher in fiscal ’20, as compared to fiscal ’19 and benefited from the sales mix within the Automotive and Industrial segments, including increased sense of sales and increased sales in the interface segment, but were negatively impacted by sales volume reductions, due to the impact of COVID-19 and foreign currency translation. Non-GAAP adjusted gross margins, a financial measure, which excludes expenses for initiatives to reduce costs and improved profitability and purchase accounting adjustments in the applicable period, were higher in fiscal ’20 as compared to fiscal ’19. Fourth quarter GAAP and selling and administrative expenses as a percentage of sales decreased 370 basis points year-over-year to 8.6% compared to 12.3% in the fiscal ’19 fourth quarter. The fourth quarter figure was attributable to long term incentive plan accrual adjustments, lower performance-based cash compensation expenses, and lower salary resulting from COVID-19 cost saving actions.

Adjusted selling and administrative expenses as a percentage of sales, a non-GAAP financial measure, decreased slightly to 11.6% from 12% in the fiscal 2019 fourth quarter. This excluded acquisition-related costs, expenses for initiatives to reduce overall costs and improved profitability, and long-term incentive plan accrual adjustments in the applicable period.

Moving to year-to-date margins on slide 10. Year-to-date GAAP gross margins improved 100 basis points, but non-GAAP adjusted gross margins improved by only 20 basis points in the year-over-year comparisons. Gross margins were affected by the impact of COVID-19 and the UAW labor strike at GM, with negative impact of foreign currency translation and lower radio remote controls sales. These items were partially offset by the benefit of a full year of Grakon sales and increased sensor sales.

Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce costs and improve profitability and purchase accounting adjustments in the applicable period. Year-to-date GAAP selling administrations as a percentage of sales decreased 290 basis points year-over-year, positively impacted by lower stock-based compensation expense, the fiscal ’20 benefit from the fiscal ’19 actions to and initiatives to reduce costs; lower acquisition costs and selling and administrative expense attributable to Grakon, which is lower as a percentage of sales at Methode as a whole. Non-GAAP selling and administrative expenses as a percentage of sales, which exclude acquisition-related costs, operational improvements and long-term and incentive plan accrual adjustments decreased by 50 basis points on a year-to-date basis.

Shifting to EBITDA on slide 11; the company generated $54.5 million in the fiscal ’20 fourth quarter versus $46.1 million in the same period last year. The EBITDA figure was accomplished in spite of the significant headwinds from the COVID-19 pandemic, which reduced sales by $85 million. Adjusting for expenses for initiatives to reduce overall costs and improved operational profitability, acquisition related costs and long-term incentive plan accrual adjustments in the applicable period, fourth quarter fiscal ’19 adjusted EBITDA was $47.2 million as compared to $48.3 million in the current period.

Moving to the year-to-date EBITDA on slide 12; the company generated $207.1 million in fiscal ’20 versus $155.2 million in the same period last year, in spite of the impact from COVID-19 and the UAW strike at GM. Adjusting for expenses for initiatives to reduce overall costs and improve operational profitability, acquisition related costs and long-term incentive plan accrual adjustments in the applicable period, fiscal ’19 adjusted EBITDA was $184.9 million as compared to fiscal ’20s $203.7 million. The improvement is primarily attributable to higher EBITDA from Grakon, 12 months of activity versus 7.5 months and new product launches, partially offset by the adverse impact from COVID-19 and the UAW strike at GM.

A few other financial items to review; year-over-year, intangible asset amortization expense in fiscal ’20 increased $2.9 million or 18% to $19 million, due to amortization expense related to the Grakon acquisition, partially offset by lower amortization in the interface segment. In fiscal ’20, we invested approximately $45 million in capital expenditures, mainly to support programs and launches in North America and Europe, and our facility expansion in India.

Year-to-date depreciation expense for fiscal ’20 was $23 million. Our year-to-date tax rate of 17% was higher than the 11.6% in fiscal ’19. This is mainly due to increased income and higher tax rate jurisdictions, and increase of tax reserves, less investment tax credits and lower benefits realized from the finalization of the transition tax from U.S. tax reform.

Let’s move to slide 13; free cash flow, as defined as net income plus depreciation and amortization, less capex for fiscal ’20 was $126.6 million, as compared to $85.1 million in fiscal ’19. The cash flow figure represents a record for Methode. As shown on slide 14, we have used some of our cash generation to pay down debt. We have reduced net debt by nearly $75 million since the beginning of the fiscal year and since the acquisition of Grakon, we have reduced our net debt by nearly $112 million. We ended the fourth quarter with $217.3 million in cash, which includes the $100 million precautionary draw on the credit facility we initiated in March. Our debt-to-EBITDA ratio, which is used for our bank covenants, is approximately 1.7. This figure includes the impact of the proactive $100 million draw we initiated. Without to draw, the ratio would have been 1.2.

Please move to slide 15, to look at our key drivers to our EBITDA performance for fiscal ’20. Looking at the EBITDA based on our $155 million of EBITDA in fiscal ’19 and adding EBITDA from a full year of Grakon, which is approximately $24 million. Adding EBITDA from our new automotive and laundry program launches of approximately $18 million. Benefits from the cost we incurred in fiscal ’19 for initiatives to reduce costs and improve profitability of around $11 million. Adding back the costs we incurred in fiscal ’19 related to acquisitions and initiatives to reduce costs and improve profitability of around $29 million and increasing our anticipate our international government grant income, which includes COVID-19 assistance of $6 million, and subtracting the negative impact of COVD-19, the UAW labor strike and other collective net impacts to the business for a total of minus $36 million.

Don, that concludes my comments.

Donald W. Duda — Director, President and Chief Executive Officer

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

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions]. We’ll take our first question from Ryan Sigdahl with Craig-Hallum.

Ryan Sigdahl — Craig-Hallum — Analyst

Great. Thanks guys for taking my questions.

Donald W. Duda — Director, President and Chief Executive Officer

Good morning, Ryan.

Ryan Sigdahl — Craig-Hallum — Analyst

First, just want to start — this past year, as well as challenging as it can get it seems with UAW strike late last year, COVID shutdowns more recently. I know you’re not giving specific guidance and understandably so. But directionally, is it reasonable to assume the key financial metrics can improve year-over-year?

Donald W. Duda — Director, President and Chief Executive Officer

You say cannot improve?

Ryan Sigdahl — Craig-Hallum — Analyst

Well I said can or can’t, I said can. It seems like some of those headwinds will will pass here and should be a better year this year. But just curious directionally, any commentary you can make on kind of key financial metrics, revenue, margins, free cash flow, etc?

Donald W. Duda — Director, President and Chief Executive Officer

I think by — the first quarter being now let’s call it somewhat unpredictable, and being shut down for really the first half of the quarter, I think we’re destined not to have as good a year as we had last year. Now having said that, once we get to more normalized production and we don’t know when that’s going to going to be, then we’re going to see the benefits of everything we did in fiscal ’20. But at this point, without knowing what the over the next three, four, five months hold, it’s hard to predict that we are going to see an upturn over last year. Now, perhaps on an annualized basis or a run rate basis, we will, but not — I can’t say that at this time.

Ryan Sigdahl — Craig-Hallum — Analyst

As we think about maybe a good segue, as we think about the current quarter we’re in, to Q1, maybe any commentary on the COVID impact and what you’re seeing kind of the production schedules for Q1 relative to Q4 and how much COVID may be impacted each of those quarters?

Donald W. Duda — Director, President and Chief Executive Officer

Well COVID hit the tail and well, really six weeks into the fourth —

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

Mid March.

Donald W. Duda — Director, President and Chief Executive Officer

Yeah, Mid-March starting a little bit. And that was simultaneous shutdown of customers around the world. So the impacts are — and then really continued until just a few a few weeks ago. And as I said in my prepared remarks, none of these facilities closed, we were shipping some products, that were more essential. But as I think Ron said, $85 million down in the quarter and really, as of today, the schedules are still erratic, and around the world, it’s just not in the U.S., customers are releasing product and then putting a whole lot and releasing other product, they’re trying to navigate consumer demand, and really,, when I look forward, it’s one thing for the automakers and our other customers to replenish their supplies, but we really have to see what the consumer demand is, and we don’t know that. There have been some good sales month and April, was good in the U.S., not as much in Europe, but as we look to the future, it’s still very much unknown. Do we expect it to stabilize at some point? Yes. But the current increase in COVID cases in the U.S., gives me some pause on that, and we really don’t know what the fall is going to bring. Ron, I don’t know if you have…

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

Yeah, I think, based on those levels, with the revenue decreases that were experienced, depending on how much that carries over in the fiscal — the next fiscal year is going to be hard to maintain margins and things of that nature, just due to the negative leverage we’re going to have from decreased sales and to the degree of that, it just happened to be on the degree of the recovery, when everything is stabilized, so…

Donald W. Duda — Director, President and Chief Executive Officer

No, what we are doing is, as we said, we are taking actions to streamline our organization, much like we’ve done in years past and one of our base strategies is continuous improvement. So we are taking actions to reduce our cost basis and our S&A, which will benefit us as things start to normalize. But the question is, when do they normalize.

Ryan Sigdahl — Craig-Hallum — Analyst

Yeah no, that’s fair. And I appreciate the color. Switching over to interface, can you break down the benefit from the major appliance program launch, which was good to see versus the higher legacy data solution product? And then secondly, is $19 million-ish revenue that you had in the quarter, is that a good run rate, kind of thinking about the new appliance program launch you had?

Donald W. Duda — Director, President and Chief Executive Officer

The $19 million, correct me if I am wrong Ron, also included our auto launches. Correct?

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

It did, yes. So we’re sitting here at — on the interface. We were at about $60 million for the year last year. So yeah, I think that would be — with the new launches and everything and full launch, the data solutions were up a little bit. They were considered essential business and we were able to continue shipping. So we got some nice — a little bit of an uplift during the quarter. But it’s hard to say the rest of the year, what that would look like into this fiscal year.

Donald W. Duda — Director, President and Chief Executive Officer

But to just add to that, we would expect that the launch of the — just the laundry program for our key customer will continue. Now again, that could be affected by consumer confidence, but we would expect that they would have — all things being equal, they would have a better year than what they’ve have had, because the launch was so delayed.

Ryan Sigdahl — Craig-Hallum — Analyst

Good. One last one for me and then I’ll turn it over. Curious what you can say or what potential or maybe you have content worked already. But some of the newcomers and EVs; so Nikola, Rivian, etc, anything you can comment on those?

Donald W. Duda — Director, President and Chief Executive Officer

I can’t comment exactly what the programs are. We have Rivian programs and that’s actually a key focus for us. And then we are — and I am asking someone to look up what we’re doing with the other. Okay. We are working with both of those. Although I can’t tell you to what degree. We got our hand slapped by another customer for doing that. But we are working with them. And certainly our product fits very well.

Ryan Sigdahl — Craig-Hallum — Analyst

Good. That’s it from me. Thanks guys, good luck.

Donald W. Duda — Director, President and Chief Executive Officer

Thanks Ryan.

Operator

[Operator Instructions]. We’ll go next to Matt Sheerin with Stifel.

Matt Sheerin — Stifel — Analyst

Yeah, hi, it’s Matt Sheerin from Stifel. Thanks for taking my question. Your commentary regarding the sort of erratic order environment from customers, and not as surprised, but could you give us some view in terms of whether you think there is some inventory work-down that’s happening, or is it more just a question of your customers trying to understand what their end demand is, and that’s why we are adjusting the order schedules?

Donald W. Duda — Director, President and Chief Executive Officer

I would say the latter, and if anything, what we’ve seen in the initial restart here is inventory replenishment. Replenishment there, looked like we would be able to normalize it, but our view to navigate in an erratic demand. I don’t want to minimize it, but I don’t think it’s any more complicated than that. Now dealer traffic has been busier than earlier, so that gives us some optimism that consumer confidence still remains strong enough to bolster auto sales.

Matt Sheerin — Stifel — Analyst

Well, thank you for that. And if you look at, I know that IHS is calling for significant production growth in Q3 — calendar Q3, just on production and factories coming back. But how do you correlate to actual production, in terms of when you see orders start to uptick?

Donald W. Duda — Director, President and Chief Executive Officer

Very good question. We have the benefit of customer releases. And normally in auto, where weekly and monthly releases are very reliable. And perhaps as you go out three and six, months they get a little softer. But we’ve seen tremendous volatility in even the weekly schedules, which is what causes us, I guess, concern. And I agree the IHS is saying Q3. So — and we also look at that, we look at LMC, we look at IHS and the predominant benefit we have is looking at our releases. But right now, we don’t see — I don’t see the correlation. When we — yes, I think at some point, whether it’s Q3 calendar, it’s also important that any uptick in demand, we can respond to — we’re ready. We have looked at all of our supply lines, all our vendors and inventory and if — once that increases, and it will increase. It’s not a matter of if, it’s when. If the customer wants the product, we definitely can ship it, and we had no customer delays since the crisis started. We had some vendor issues we had to deal with and I’m talking across the board, not just auto. But we have not delayed the customer, and we certainly won’t, going forward. So if the demand is there, we will definitely supply and see the benefit from it.

Matt Sheerin — Stifel — Analyst

Okay. And your lead times are at normal levels right now, could you remind us what they are?

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

The lead times?

Matt Sheerin — Stifel — Analyst

Yeah.

Ronald L.G. Tsoumas — Vice President, Corporate Finance and Chief Financial Officer

For the customer?

Donald W. Duda — Director, President and Chief Executive Officer

I mean, it’s just in time — back on demand.

Matt Sheerin — Stifel — Analyst

Okay. So you have inventory in the hubs. Okay, all right. Okay, thanks so much for the color. I appreciate it.

Operator

And there appear to be no further questions in the queue. At this time, I’d like to turn the call back over to Mr. Duda for any closing remarks.

Donald W. Duda — Director, President and Chief Executive Officer

Tom, thank you very much. We’ll close with wishing everyone a very safe and enjoyable independence holiday. Thank you for listening today.

Operator

[Operator Closing Remarks]