Methode Electronics Inc. (NYSE: MEI) Q1 2021 earnings call dated Sep. 03, 2020
Corporate Participants:
Robert Cherry — Vice President, Investor Relations
Donald W. Duda — Director, President and Chief Executive Officer
Ronald L. G. Tsoumas — Chief Financial Officer and Vice President, Corporate Finance
Analysts:
Matt Sheerin — Stifel — Analyst
Ryan Sigdahl — Craig-Hallum Capital — Analyst
Presentation:
Operator
Good day, ladies and gentlemen, and welcome to your Methode Electronics First Quarter Fiscal 2021 Results Conference Call. [Operator Instructions]
At this time, it is my pleasure to turn the floor over to your host, Vice President of Investor Relations, Mr. Robert Cherry. Sir, the floor is yours.
Robert Cherry — Vice President, Investor Relations
Thank you, operator. Good morning and welcome to Methode Electronics fiscal 2021 first quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2021 First Quarter Financial Results, which can be viewed on the webcast of this call or found at methode.com in the Investors section.
This conference call contain 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 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; recognition of goodwill and long-lived asset impairment charges; costs associated with restructuring activities; international trade disputes resulting in tariffs and our ability to mitigate tariffs; timing, quality, 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 Surfaces products; currency fluctuations; customary risks related to conducting global operations; costs associated with environmental, health and safety regulations; ability to withstand business interruptions; ability to successfully benefit from acquisitions and divestitures; investment in 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 positions; income tax rate fluctuations; ability to keep pace with rapid technological changes; breaches to our information technology systems; ability to avoid design or manufacturing defects; ability to compete effectively; ability to protect our intellectual property; success of recent acquisitions and/or our ability to implement and profit from new applications of the acquired technology; 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 good morning, everyone, and thank you for joining us today for our fiscal 2021 first quarter earnings conference call. I’m joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I have opening comments and afterwards, we’ll take your questions.
Let’s begin on Slide 4 with the business highlights from the first quarter. I’ll start with the situation with COVID-19. I continue to be proud of our employees’ incredible commitment to Methode and to supporting our efforts to provide a safe work environment. All of our facilities have remained open to some degree through this challenging period and most of our hourly employees have returned to a full work week. Our offices have systematically begun to reopen, but we’re also still making prudent use of work-from-home for our office staff. We anticipate that we will see some level of headwind risk and uncertainty from the COVID-19 pandemic throughout the fiscal year. However, as I stressed last quarter, we will continue to invest in our business for long-term growth.
Turning to the business performance. While the quarter was clearly down due to the pandemic, we saw significant rebound in automotive demand in the latter half of the quarter. As you recall, most of the auto OEMs were effectively shut down in the first half of the quarter. And when we reported our fourth quarter results, we were concerned about the stability of OEM production schedules based on the pandemic circumstances.
Please turn to Slide 5 for a summary of our financial results. Methode’s first quarter sales decreased 29.3%. Our net income decreased 26.9%. And our diluted earnings per share decreased 28% for the fiscal quarter ended August 1st of 2020. The resulting decremental net income margin of 10% was helped by cost reductions and operational efficiency initiatives. The net income in the quarter was also aided by discrete tax benefit of $7.8 million. Adding back the discrete tax benefit, the decremental net income margin would have been 19%. Ron will provide more detail on these tax items later.
Returning to the automotive business on Slide 6. It was a particularly strong quarter for awards in EV and hybrid applications. We received award of a total annual expected sales of approximately $30 million. Given our ongoing strategy to cross-sell our technologies into the space, we now expect a high-single digit percentage of our fiscal 2021 consolidated sales to come from EV and hybrid programs. This is an area where we are globally well positioned and we anticipate continued growth. I will share more on our new awards a little later.
Looking at our non-automotive markets, we saw strength in data centers and appliances on a year-over-year basis. However, other markets were negatively impacted by the pandemic, including industrial equipment and commercial vehicles, which while down are seeing forecasts improve. Operationally, we took significant S&A cost saving actions in the quarter to help mitigate the impact from the pandemic despite incurring $1.5 million in S&A restructuring costs, S&A expenses were reduced by $5.8 million year-over-year.
In regard to our balance sheet, we continue to have positive free cash flow and continue to reduce our debt in the quarter. Our liquidity is strong and our leverage stable. The strength and flexibility of our balance sheet allows us to consider multiple paths to invest in the business in order to drive growth and shareholder return.
Moving to Slide 7. During the first quarter, Methode booked a number of awards capitalizing on the strategic trends in vehicle electrification, LED lighting and data centers. The awards identified here represent a cross-section of the business wins in the quarter and represent over $36 million in annual business. In electric vehicles, we won awards for lighting, overhead console and busbar programs totaling over $22 million annually. In hybrid vehicles, we were awarded lead frame and busbar programs totaling approximately $9 million annually. I would like to emphasize that these — we are winning programs with OEMs in the US, Europe and Asia.
In non-EV LED lighting, we were awarded programs for both auto and commercial vehicle applications. Lastly, we’re also participating in the building of data centers driven by cloud computing with programs for busbars and pluggable modules. As we have stated before, Methode will continue to evolve its business with innovative, new technology and products for emerging applications and growing markets. In the medical segment, our efforts to grow the Dabir product line in the quarter continue to be hampered by the postponement of elective surgeries due to COVID-19. We are seeing some increased activity and believe that this business will return to a growth trajectory in the near future.
Looking forward, we’re only providing sales guidance and only for our fiscal 2021 second quarter due to the market risk and uncertainty from the ongoing pandemic. While we are not providing annual guidance at this time, we do intend to reassess annual guidance as soon as demand stabilizes and we are confident with our customers’ forecasts. While we have certainly seen strong demand over the last several months, it is not clear how much consumer confidence has returned versus the industry just satisfying pent-up demand, hence we remain cautious.
As I shared last quarter, Methode took actions in the first quarter to consolidate operations and further streamline our organization in order to improve efficiencies and set the stage for continued growth. These actions and any potential future actions will allow us to further improve our execution and be in a better position to grow.
To conclude, given the current global macroeconomic situation and the significant headwinds faced by Methode throughout this past quarter, I am extremely pleased that our strategy and team were able to deliver these results, generate positive free cash flow and maintain a strong balance sheet. Our focus is on navigating the pandemic situation, while continuing to execute our long-term strategy.
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 — Chief Financial Officer and Vice President, Corporate Finance
Thank you, Don, and good morning, everyone. First quarter sales decreased 29.3% or $79.3 million to $190.9 million in fiscal ’21 from $270.2 million in fiscal ’20. Sales in the first quarter were negatively impacted by COVID-19, especially in the May through mid-June timeframe. The production shutdowns mostly impacted the automotive and industrial segments. The impact of foreign currency on sales was not significant in the quarter.
First quarter net income decreased $7.6 million to $20.7 million or $0.54 per share from $28.3 million or $0.75 per share in the same period last year. First quarter net income benefited from a discrete tax benefit of $7.8 million and higher other income of $3.4 million, primarily due to COVID-19 assistance of $2.9 million.
Please turn to Slide 9. The sales drivers from fiscal ’20 first quarter to fiscal ’21 first quarter were a net $92 million sales reduction due to the impact of COVID and other lower volumes, partially offset by $14 million of new launches. Foreign currency translation reduced sales by $1 million. The impacted segments were mostly automotive and industrial.
Moving to Slide 10. First quarter gross margins were lower in fiscal ’21 as compared to fiscal ’20, mainly due to the reduced sales due to the impact of COVID. Product mix was also unfavorable as 26.6% decrease in sales in the higher-margin industrial segment negatively impacted consolidated gross margins. Fiscal ’21 first quarter margins were 23.6% as compared to 28.1% in the first quarter of fiscal ’20. The fiscal ’21 first quarter margins included $1.9 million of restructuring expense. Without the restructuring expense, fiscal ’21 first quarter gross margins would have been 24.6%.
First quarter selling and administrative expenses as a percentage of sales increased 190 basis points year-over-year to 13.9% compared to 12% in the fiscal ’20 first quarter. The fiscal ’21 first quarter figure was attributable to decreased sales and restructuring expense of $1.5 million, partially offset by lower stock-based compensation expense, lower wages and associated benefits due to salary reductions and four-day work weeks and much lower travel expense. There was no restructuring expense in the first quarter of fiscal ’20. Without the $1.5 million of restructuring expense, the selling and administrative expense as a percentage of sales for the first quarter of fiscal ’21 would have been 13.1%.
The company continues to monitor market factors and trends and will continue to evaluate possible additional actions to reduce overall costs and improve operational profitability, especially in the current COVID-19 environment. In addition to the $3.4 million incurred in the first quarter from actions taken in the first quarter, the company currently expects an additional expense of $2 million in the second quarter from those first quarter actions. The company may take additional actions in future period based upon business conditions as required.
Moving to slide 11. Net income was $20.7 million in the first quarter of fiscal ’21 as opposed to $28.3 million in the first quarter of fiscal ’20. The main drivers between the fiscal years were lower sales due to COVID, a favorable change in discrete tax items of $9.1 million, an unfavorable change in restructuring expense of $3.4 million and the receipt of $2.9 million of foreign government assistance due to COVID.
Shifting to EBITDA, a non-GAAP financial measure, fiscal first quarter ’21 EBITDA was $29.3 million versus $50.3 million in the same period last year. EBITDA was negatively impacted by the significant headwinds from the COVID-19 pandemic and included $3.4 million of restructuring expense.
A few other financial items to review. Year-over-year depreciation and intangible asset amortization expense increased slightly in the first quarter of fiscal ’21 to $12.1 million from $11.8 million in the first quarter of fiscal ’20. In the first quarter of fiscal ’21, we invested approximately $11.6 million of capex as compared to $13.2 million in the first quarter of fiscal ’20. The first quarter investment represents an approximate $45 million run rate for the current fiscal year, but it is too early to tell if the rate will be maintained throughout the remainder of the year. However, we have a strong balance sheet and intend to utilize it during this COVID impacted year to make continued investment in our businesses to grow them organically in the future.
In addition, we continue to pursue opportunities for inorganic growth. Our intent is to come out of the COVID pandemic stronger than we were when we went into the crisis by judiciously using our strong balance sheet to our long-term advantage.
We had an income tax benefit of $5.1 million as compared to a tax expense of $7.3 million in the fiscal ’20 first quarter. The main driver of the benefit in fiscal ’21 was $7.8 million of discrete tax items recorded during the quarter, mainly due to investment tax credits and other credits earned in foreign jurisdictions. In the fiscal first quarter of ’20 — fiscal year ’20, there was a discrete tax expense of $1.3 million. Without the discrete tax items, the fiscal ’21 first quarter effective tax rate would have been 17.2% as compared to 16.6% in the same period last year.
As shown on Slide 12, we did leverage gross debt by $2.3 million in the first quarter. Since our acquisition of Grakon when adjusting for the $100 million precautionary credit facility draw in March of 2020, we have reduced gross debt by nearly $108 million. Net debt increased by $4 million in the first quarter of fiscal ’21 as compared to the fiscal ’20 year end. We ended the first quarter with $211 million in cash, which includes $100 million precautionary draw on the credit facility in March.
Our debt-to-EBITDA ratio, which is used for our bank covenants, is approximately 1.9. This figure includes the impact of the precautionary $100 million draw. Without the draw, the ratio would have been approximately 1.3.
Let’s move to Slide 13. Free cash flow, a non-GAAP measure, which is now defined as cash provided from operating activities minus capex as opposed to prior to fiscal ’21 where it was defined as net income plus depreciation and amortization less capex. For the fiscal ’21 first quarter, free cash flow was $4.8 million as compared to $5.9 million in fiscal ’20.
As Don mentioned in his remarks, we are providing revenue guidance for the second quarter. The revenue range for the second quarter will be between $230 million and $250 million.
Don, that concludes my comments.
Donald W. Duda — Director, President and Chief Executive Officer
Ron, thank you very much. Melinda, we’re ready to take questions.
Questions and Answers:
Operator
Thank you. The floor is now open for questions. [Operator Instructions] And our first signal comes from Matt Sheerin with Stifel. Please go ahead.
Matt Sheerin — Stifel — Analyst
Yes. Good morning and thanks for taking my questions. I just wanted to ask about the sort of near-term order trends you’re seeing. I know that on your last quarter commentary a couple of months ago, you talked about week-to-week volatility in terms of customer order trends within automotive. Could you talk about what you’re seeing now? You obviously have some confidence, given your guidance. So any metrics you can give us and also by region in terms of demand trends that would be very helpful? Thank you.
Donald W. Duda — Director, President and Chief Executive Officer
I hesitate to use the word stabilize because while orders have been, let’s say, more predictable, the releases and so we’re still seeing a lot of variability in mix, which causes us to be concerned because usually in automotive in any of the regions, your schedules for the first, let’s say, two to three months are usually very stable. And we are still seeing volatility in that. They have increased, which gives us the ability to give at least sales guidance for the quarter, but there still is enough uncertainty as we go forward. And as I mentioned in my remarks, how much of that is pent-up demand versus the automotive business worldwide returning to some stability. So, I mean, we are cautious going forward.
To your question about the regions, the US has — I believe the automakers are rolling back up, that drives a good portion of our automotive sales, but I’ll — we’ll say they are — the mix is variable. In Europe, it really is a month-to-month type business right now. Again, usually you see three months pretty steady forecast. It is still very volatile, some months are better than others, but I will say that it has picked up.
And then, in China, we see growth there [Indecipherable] back to normal, but — and it’s probably a good way of putting. So we can’t combine all of that, I don’t want to say that I’m cautiously optimistic. I just feel better about where we are — versus where we are at the beginning of the first quarter. There it was very difficult to forecast anything. And it’s only been in the last maybe two months where things have really gone to some predictability. Ron?
Ronald L. G. Tsoumas — Chief Financial Officer and Vice President, Corporate Finance
Yeah. I would say too in terms of just like the global macro, it came out yesterday or today that August — SAAR in the US was equivalent, annualized at $15.3 million, which is up from the $4 million, but car [Phonetic] registrations in several leading European countries came out today was balanced. So that could be a precursor for decreased demand in that. So getting a little bit better visibility, but certainly not to the level of visibility we had going out with the high tech [Phonetic] with as much confidence as we had before. So, I think the sweet spot is we were able to comment on the second quarter, but that’s as far as we can go.
Donald W. Duda — Director, President and Chief Executive Officer
And then, Matt, I think we’re anxious to see, once replenishment is complete and I don’t know exactly what percentage it is right now, I’m not very scientific, but I drill by dealer labs in Wisconsin and in Illinois and they’re pretty sparse yet [Phonetic]. So, we really have to see what does the consumer do maybe in our third quarter or maybe after the first of the year, I think that will really tell what things are going to look like going forward.
Matt Sheerin — Stifel — Analyst
Fair enough. That’s quite helpful. And just as a follow-up regarding your commentary on the EV and hybrid and it sounds like there is sort of an acceleration there perhaps because of your program wins, but also speaks to the investments by your customers in terms of making that a priority despite everything going on COVID-related. Is that what you’re seeing from your customers?
Donald W. Duda — Director, President and Chief Executive Officer
Yeah. We’re not seeing customers back-off on launches in any way shape or form. I mean, even in March/April/May, the customer was clearly saying, hey, stay focused. Perhaps there is a program delay of a little bit, but nothing of significance. So that remains a focus for them. We’ve been in the power distribution business in busbar since the days of IBM Mainframe. So, we were well suited to provide busbars and battery disconnect units and so on to the EV manufacturer, so — and we can provide that on three continents, all on the same manufacturing and quality level. So we see that continuing to grow. We’ll probably grow at the market rate and probably a little bit better. So, it’s an area that we plan to be in and we’re seeing that that strategy we started years ago is starting to pan out.
Matt Sheerin — Stifel — Analyst
Okay. All right. Thank you very much.
Donald W. Duda — Director, President and Chief Executive Officer
Thank you.
Ronald L. G. Tsoumas — Chief Financial Officer and Vice President, Corporate Finance
Thank you.
Operator
Our next question comes from Ryan Sigdahl with Craig-Hallum Capital. Please go ahead.
Ryan Sigdahl — Craig-Hallum Capital — Analyst
Great. Thanks guys for taking my questions.
Donald W. Duda — Director, President and Chief Executive Officer
Hi. Good morning, Ryan.
Ryan Sigdahl — Craig-Hallum Capital — Analyst
Just curious I know there’s still quite a bit of uncertainty, sounds like a little better visibility that maybe over three months ago. But as far as gross margins and margins go, as you look at production from OEMs and you guys ramping back up, is it reasonable to get back to kind of historical margins in next quarter, the current quarter we’re in or is it — will it take a little bit longer to get back there?
Donald W. Duda — Director, President and Chief Executive Officer
I’ll let Ron comment a little bit on it, but it is all volume related. There is nothing that systematically that would say we couldn’t or shouldn’t get back to those levels. When? That’s little harder to predict, but it is volume-related. There’s no issue that we have.
Ronald L. G. Tsoumas — Chief Financial Officer and Vice President, Corporate Finance
Yeah. And Ryan, there is also a degree of mix with the Class 8s being down year-over-year and that’s a higher margin business for us. So, to the extent that, that decrease is faster than or comes on track at a rate different than, let’s say, the automotive segment. There could be a mix impact of that as well.
Ryan Sigdahl — Craig-Hallum Capital — Analyst
Got it. And then, just wanted to circle back to kind of the EV awards in the quarter, but were those specifically for existing customers from the new OEMs? And then, as you look at that pipeline, Don, I know you mentioned you guys expect to grow kind of in line to better, but how are you guys doing in those negotiations, bids relative to historical win rates?
Donald W. Duda — Director, President and Chief Executive Officer
For the established EV players, I think we do quite well. I mean, we do track every quote that Methode does worldwide, we track wins and losses. And in the EV area, we’ve done quite well. And if you think about it, as I said earlier, we’ve been on the busbar business for a long-time, but we bring the automotive pedigree along with that. So that has — that gives us an advantage over maybe someone else that can make a busbar, but can they make it to our quality standards. That helps us quite a bit.
And then, I mentioned the established EV, but we do provide product to the start-ups and we’re cautious on accounts receivable, but we’re very well situated there. And there it’s hard to predict which one will be the winner in that, but — so I think we’re pretty well covered in the EV market and we continue to develop products for the market.
Ryan Sigdahl — Craig-Hallum Capital — Analyst
Great. Last one for me and then I’ll hop back in the queue. But just on capital allocation, it sounds like M&A is inorganic is a pretty big focus. But how do you think about kind of M&A multiples today versus where your stock trades and potentially repurchasing shares instead?
Donald W. Duda — Director, President and Chief Executive Officer
That’s a tough question. My first choice is an accretive acquisition. I think long-term that pays higher dividend for Methode than a discrete stock repurchase. But having said that, as our balance sheet grows at a certain point, I wouldn’t rule that out. We’ve done in the past, but I don’t want to speak for the Board, but I think we all feel that organic growth is critical, but also inorganic through acquisitions, the prices have not dropped and we haven’t announced an acquisition. We haven’t seen anything that fits prices are high, interest rates are low, the pandemic continues into next year will some of the opportunities be less costly potentially. So I wouldn’t rule out a stock buyback. That’s — we’ve done it before, but our emphasis is on growing the business.
Ryan Sigdahl — Craig-Hallum Capital — Analyst
Great. Thanks, guys. Good luck.
Donald W. Duda — Director, President and Chief Executive Officer
Thank you.
Operator
At this time, there are no further signals. We turn to Mr. Don Duda for closing remarks.
Donald W. Duda — Director, President and Chief Executive Officer
Thank you, Melinda. We will conclude the call. Thank you, everybody, for listening in and wish everyone a safe and enjoyable Labor Day. Thank you all.
Operator
[Operator Closing Remarks]