Methode Electronics Inc. (MEI) Q3 2021 Earnings Call Transcript

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Methode Electronics Inc. (MEI 0.17%)
Q3 2021 Earnings Call
Mar 4, 2021, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. And welcome to Methode Electronics Third Quarter Fiscal 21 Results. [Operator Instructions]

It is now my [Technical Issues] to your host, Rob Cherry, Vice President of Investor Relations. Sir, the floor is yours.

Robert Cherry -- Vice President, Investor Relations

Thank you, operator. Good morning and welcome to Methode Electronics fiscal 2021 third quarter earnings conference call. For this call, we have prepared a presentation entitled Fiscal 2021 Third 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.

Donald W. Duda -- President & Chief Executive Officer

Thank you, Rob, and good morning everyone and thank you for joining us for our fiscal 2021 third quarter earnings conference call. I'm joined today by Ron Tsoumas our Chief Financial Officer. Both Ron and I will have opening comments and then we will take your questions.

Let's begin with the business highlights on Slide 4. Our sales for the quarter were $295 million as noted in our release this morning, the company's accounting period for this quarter included 13 weeks as compared to 14 weeks for the third quarter of fiscal 2020. Our discussions of year-over-year comparative results should be viewed in this context. For illustration, our sales on a weekly run rate basis and excluding favorable currency translation were up 8% from the prior year. We share this to give investors insight on how we view the underlying strength of our business, which clearly improved year-over-year. While the top line was strong, we do have some headwinds to gross margin in the quarter. Supply chain disruptions led to additional costs such as premium freight as well as to factory inefficiencies. Moving forward, these challenges will linger and be joined by demand disruptions caused by the ongoing semiconductor and potentially other material shortages, some of which are related to the recent extreme weather events in the US. This is driving a level of near-term uncertainty that can be seen in our wide guidance range for the fourth quarter.

However, none of these issues are systemic and we expect most to be resolved by the middle of this calendar year. Our confidence in the situation improving is evidenced by our decision to give an early indication of our anticipated sales for fiscal 2022 of over 10% organic growth. In addition, as the commercial vehicle market continues to rebound, our sales mix is expected to further improve gross margin.

Turning to our Automotive business. We continue to see strength in demand. Our sales in EV grew and we had a strong Awards for Power, Lighting and User Interface programs in the quarter. Focusing on EV. Last quarter we reported that sales into EV applications were over 9% of consolidated sales and were expected to be in the high single-digits for fiscal 2021. This quarter, EV sales were over 12% of consolidated sales and we now expect that number to be over 10% for fiscal 2021. Furthermore, our healthy pipeline of EV programs now gives us visibility to project that this percentage will be in the mid-teens in fiscal 2022. Methode's combination of user interface, LED lighting and Power Distribution Solutions is a winning formula in EV and positions us well for continued growth in this exciting market.

Regarding our balance sheet. We generated over $80 million in free cash flow and significantly reduced our net debt in the quarter. The debt reduction was driven by the full repayment of our $100 million revolver draw from March of last year. We continue to have ample liquidity and our net leverage ratio was now near zero. 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 ultimately shareholder return.

In addition to the COVID-19 pandemic, we faced a growing impact from a semiconductor shortage in the quarter. While the COVID-19 situation is improving, the ongoing operating issues from it remain. In regard to the chip shortage situation, the impact of Methode in the third quarter was minimal, however, we do anticipate a financial impact in our fourth quarter and beyond as a result of the aforementioned issues as well as other potential supply chain disruptions.

Moving to Slide 5. Methode had its best quarter of this fiscal year for booked awards. These awards continue to capitalize in key market trends like vehicle electrification, LED Lighting in Auto and Sensors in e-Bikes. The awards identified here represent a cross-section of the business wins in the quarter and represent over $50 million in annual business. In vehicle electrification, we won awards for busbar, power distribution and user interface programs. We continue to win programs with OEMs globally in auto, commercial truck and even charging station applications.

In non-EV LED Lighting, we were awarded programs for several auto applications. We also continue to participate in the growth of e-Bikes, which utilizes our proprietary Magneto-elastic technology. Lastly, we won two sizable awards for User Interface programs with international automotive OEMs. For the first three quarters of the fiscal year, Methode has booked orders of over $150 million in potential annual sales. We continue to build on our foundation for organic growth.

Regarding the anticipated roll off of our largest auto program, while we can't comment on our customers' timing, we are pleased that our strong new program bookings over the last several quarters has put us on a track in aggregate to replace the sales from that program. We are also pleased to protect that our sales from any single customer is expected to drop below 25% from a high of approximately 50% four years ago, all while we continue to grow our top line. We are definitely making progress on reducing both customer and program concentration.

Turning to Slide 6. I would like to elaborate further on our footprint in EVs. As I've shared with you before, Methode has become uniquely qualified three-pronged solution provider for EVs. Those solutions includes, User Interface, LED Lighting and Power distribution. The architecture of EV is generally divided into two parts. The Top Hat and the Skateboard. The Top Hat is essentially a body of the vehicle and varies from model to model. The Skateboard is the chassis or framework of the vehicle. As many of you know this type of vehicle architecture is a game changer with EVs, as it can be standardized and leveraged across multiple models and platforms. On the Top Hat, Methode offers its traditional vehicle solutions of User Interface and LED Lighting, along with some EV specific solutions such as charging ports. These charging ports are fairly complex and include features such as actuators and lighting, in addition to the power connection itself.

On Slide 7, we show Skateboard. This is where Methode leverage its unique combination of auto grade manufacturing operations, our Auto pedigree and Power distribution expertise to supply various busbars, connectors and battery disconnect units to the EV OEMs. We are also gaining traction with sensor solutions for By-wire systems and battery monitoring. However, it is in the Power distribution where the largest content growth opportunity lies. Historically, our participation with Power products and internal combustion vehicles was minimal. In EVs it is quickly growing as -- and has reached approximately half of our product sales for EV applications. Consequently, Methode has a clear opportunity to incrementally grow our content per vehicle with the transition to EVs. The additional content in EV could range from 20% to over 100% of our current content on an internal combustion vehicle. As I've said in the past, EV is a definite organic growth tailwind for Methode.

To conclude, given the recent supply chain challenges and the ongoing pandemic situation, I am extremely pleased that our strategy and our team were able to deliver at the high end of our previous guidance, generate significant free cash flow and win substantial new program awards in the quarter.

At this point, I'll turn the call over to Ron who will drive more detail on our third quarter financial results. Ron?

Ronald L.G. Tsoumas -- Chief Financial Officer & Vice President, Corporate Finance

Thank you, Don, and good morning everyone. Please turn to Slide 9. Please note that the third quarter of fiscal year '21 contains 13 work weeks, whereas the third quarter of fiscal year '20 had 14 work weeks. Third quarter sales were $295.3 million in fiscal year '21 compared to $285.9 million in fiscal year '20, an increase of $9.4 million or 3.3%. The year-over-year quarterly comparisons included a favorable foreign currency impact on sales of $9.7 million in the current quarter. On a weekly run rate basis and excluding the foreign currency impact, net sales were up a solid 7.6%, compared to the same quarter of fiscal year '20. The increase was due in part to higher sales of Electric and Hybrid Vehicle Solutions.

Third quarter net income decreased $9.3 million to $31.9 million or $0.83 per diluted share from $41.2 million or $1.09 per diluted share in the same period last year. In addition to one week less of production activity in the current fiscal quarter, the decrease was primarily due to premium freight and factory inefficiencies resulted from supply chain disruptions due to COVID-19 and to a lesser extent increased tariff expense and product sales mix. Also contributing to the decline was lower other income of $2.5 million and higher income tax expense of $1.8 million.

Please turn to Slide 10. Third quarter gross margins were lower in fiscal year '21 as compared to fiscal year '20, mainly due to premium freight and factory inefficiencies resulted from supply change disruptions due to COVID-19 and the mentioned tariff expense and product sales mix. Fiscal year '21, third quarter margins were 24.6% as compared to 27.7% in the third quarter of fiscal year '20. The premium freight and other expenses resulting from inefficiencies in the supply chain that were experienced in the third quarter are expected to continue in the fourth quarter. However, we do not believe these issues are systemic and based on our knowledge at this time, it will gradually be resolved in the fourth quarter with lesser impact to the first quarter of fiscal year '22.

Third quarter selling and administrative expenses as a percentage of sales decreased 50 basis points year-over-year to 11% compared to 11.5% in the fiscal year '20 third quarter. The fiscal year '21 third quarter percentage was attributable to lower compensation expense, lower travel expense and restructuring costs, partially offset by higher stock-based compensation expense. The decrease in compensation expense was primarily related to the benefit of restructuring actions taken in the first quarter of fiscal year '21. While we anticipate an increase in the SG&A percentage on a go-forward basis due to a full year of LTIP amortization on the restricted stock units and more normal travel expense, we expect the future SG&A expense percentage to be more in line with our historical norms, which is still yield and efficient flow-through from gross margins operating income.

Regarding our restructuring activities the third quarter expense was $700,000 and the year-to-date third quarter expense was $8.3 million. The company currently expects an additional restructuring expense of $200,000 in the remainder of the fiscal year, resulting from the previous quarters actions. The vast majority of the restructuring took place in the first half of the fiscal year.

Please turn to Slide 11. In addition to the gross margin and SG&A items mentioned above, two other non-operational items significantly impacted net income in the third quarter of fiscal year '21 as compared to the comparable quarter last fiscal year. First, other income net was lower by $2.5 million, mainly due to lower government assistance between the comparable quarters. Second, income tax expense in the third quarter of fiscal year '21 was $4.6 million or 12.6% as compared to a tax expense of $2.8 million or an effective tax rate of 6.4% in the third quarter of fiscal year '20. The 12.6% effective tax rate for the quarter was less than the estimated tax rate due to the benefits of some tax planning enacted in the third quarter, which was retroactively applied to the first quarter of the current fiscal year. We expect to benefit from the third quarter tax planning in the current fourth quarter, which will result in an estimated fourth quarter effective tax rate of 15%, down from the previously guided rate of 17%. Shifting to EBITDA, a non-GAAP financial measure. Fiscal year '21 third quarter EBITDA was $51.3 million versus $58.7 million in the same period last year. EBITDA was negatively impacted by the higher costs I previously noted.

Please turn to Slide 12. We reduced gross debt by $103 million in the third quarter, resulting from the full repayment of the $100 million precautionary draw we initiated in March 2020. Since our acquisition of Grakon in September 2018, we have reduced gross debt by $113 million. Net debt, a non-GAAP financial measure decreased by $108.9 million in the third quarter of the fiscal year '21 as compared to the fiscal year '20 year-end from $134.8 million to $25.9 million. We ended the quarter with $218.7 million in cash. Our debt to trailing 12 month EBITDA ratio, which is used for our bank covenants is approximately 1.3. Our net debt to trailing 12 months EBITDA ratio was 0.1.

Please turn to Slide 13. Free cash flow, a non-GAAP financial measure, which effective in fiscal year '21 is defined as cash provided from operating activities minus capex. For the fiscal year '21 third quarter, free cash flow was $82.8 million as compared to $6.7 million in the third quarter of fiscal '20. The strong free cash flow performance was driven by an approximately $40 million favorable change in working capital in the quarter. While this level of working capital execution is not likely to be sustainable, especially as we navigate through supply chain challenges, we anticipate continuing our history of consistently generating predictable cash flows, which will allow for ample funding of future organic growth, inorganic growth and return of capital to the shareholders.

In the third quarter of fiscal year '21, we invested approximately $4.9 million in capex as compared to $8.1 million in the third quarter of fiscal year '20. The lower third quarter capex was simply due to timing as opposed to any conscious effort to curtail capex. We approved capex during the quarter that was not reflected in the cash flow statement as the actual outlay for these improved expenditures will occur in future reporting periods. We have a strong balance sheet and we'll continue utilizing it by continued investment in our businesses to grow them organically in the future. In addition, we continue to actively pursue opportunities for inorganic growth.

Please turn to Slide 14. As Don mentioned in his remarks, we are providing revenue and earnings per share guidance for the fourth quarter which is subject to disruption at any time due to a variety of factors including direct and indirect impacts from the ongoing COVID-19 pandemic situation, the semiconductor supply shortage and potential challenges from supply disruption resulting from the severe weather experienced in the US in mid-February. The revenue range for the fourth quarter is between $270 million and $300 million. Diluted earnings per share range is between $0.60 and $0.82. The wide range is due to the uncertainty from the supply chain disruption for semiconductors and other material on both Methode and its customers. Factors that could result in us moving toward the higher end of the sales rate include higher sales due to lesser supply disruption to us and/or our customers, which would result in higher demand for all our products. Lesser disruption would also minimize the cost of sales impact from premium freight, factory inefficiencies and to a lesser extent tariffs and other logistic factors such as port congestion.

Don that concludes my comments.

Donald W. Duda -- President & Chief Executive Officer

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

Questions and Answers:

Operator

Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] And your first question is coming from Luke Junk. Your line is live.

Luke Junk -- Robert W. Baird -- Analyst

Good morning. Don wondering for the first question, if you could just talk about your current view of the chip shortage and what your customers are telling you at this point in here in early March and curious within that if you think you're waiting to the trucks and SUVs in the Auto business should help to cushion the company to some extent with the margin as we go through the...

Donald W. Duda -- President & Chief Executive Officer

Let me answer the last part first. Yes, I don't want to speak for the customers, but we do know that across the board customers are reallocating to the models that are selling for them. So we do benefit from that. But it's very difficult to project how that will work out. We said in our third quarter that it was minimal. But we are seeing the effect of it in our fourth quarter and our guidance clearly reflects it. And so, when -- we're being told it will mitigate, it runs the gamut. The latest we heard is maybe in the middle of the year. But we've also heard longer as well. So it's very difficult from where we said to predict that. And again, that's why we gave a wide guidance range.

Luke Junk -- Robert W. Baird -- Analyst

Okay, understood. Second question I had is, by my count you show about a dozen or so EV product applications on Slide 6 and 7. There are a couple maybe two or three that you'd highlight as an emerging opportunity for the company beyond what we've already know is your strengths in terms of busbars and LED Lighting is your key products, for example.

Donald W. Duda -- President & Chief Executive Officer

Sure. One of the ones we like, I mentioned in my prepared remarks are the charging ports. They've -- They're fairly complicated. There's actuators in them and so there's coils in them, there is connectors, there is Class A surfaces, so we're -- we don't have any awards at the moment that I can announce, but that is an area that we are pursuing. The other area, we think sensors and cameras and we do a side repeater for one of the major EV companies that has a camera in it. But we're also looking at putting cameras on Class 8 trucks as well, not so much from an electric standpoint, I guess, but as you go into some of the other vehicles, putting -- the smaller delivery vehicle putting external cameras and it's another area that we are working on.

From a Skateboard standpoint, the battery disconnect unit, we have some business with that now. Those are fairly complicated. And then there is a power distribution unit as well. Those are areas that -- those are high dollar content for the vehicles. And again, we're uniquely qualified to produce those. So I think those will be the key areas.

Luke Junk -- Robert W. Baird -- Analyst

Okay. Great, thank you for that. And then last question I had is, if you could just remind us of your overall commercial vehicle exposure in industrial. And more importantly what your outlook for that business is right now based on the increase in order rates that we've seen and as build rates start to recover?

Donald W. Duda -- President & Chief Executive Officer

I mean we follow ACT and we look at somewhat flat, I shouldn't say that, because it is increasing in our third and fourth quarter, but we see it mid next year, continuing to go up into '23. Not sure if I would call it the peak, but I think that's where ACT has it. We tend to outpace ACT. We'll just have to see how strong the recovery is, and I would also point out that some of that is just catching up with demand.

Ronald L.G. Tsoumas -- Chief Financial Officer & Vice President, Corporate Finance

We think too that this trend going forward too will provide opportunity for margin expansion into the next year. The whole segment has we get into more vehicle electrification and the uptick in commercial vehicle, that's our highest margin segment. So to have more activity there should the [Indecipherable] so to speak. So that's a good thing we watch very closely.

Luke Junk -- Robert W. Baird -- Analyst

Great, thank you for that. I'll go ahead and leave it there.

Donald W. Duda -- President & Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Your next question is coming from Ryan Sigdahl. Your line is live.

Ryan Sigdahl -- Craig-Hallum Capital Group -- Analyst

Good morning, guys. Thanks for taking my question.

Donald W. Duda -- President & Chief Executive Officer

Good morning, Ryan.

Ryan Sigdahl -- Craig-Hallum Capital Group -- Analyst

Just want to dive in, you mentioned margin expansion next fiscal year, which is helpful, directional commentary. Just curious there was a lot of headwind challenges obviously this year. But as we -- looking back, maybe to fiscal '20, EBITDA margins were close to 20%. I guess is that a reasonable baseline you mentioned more content, higher margins, I guess directionally, is that a good baseline for next year or you think you can do better than that or is there reasons to think it will be worse?

Donald W. Duda -- President & Chief Executive Officer

That requires us to get in the guidance for next year. Let me see what we can say there. We've talked about margin expansion into because of the Class 8, and so if I were to look at the industrial margins, I wouldn't -- would say we would benefit from that increase, also we have a better margin mix in some of the new products. Keep in mind, those won't launch in Q1 of fiscal '22, but the BDUs and the PDUs do carry much higher margins. So we'll -- I would expect from an industrial standpoint, we would see margin and EBITDA expansion from that. Auto, that's a tougher one. It really depends on chip shortages and what the -- the flows on the flow through, but the actual demand is from the consumer. Right now we're benefiting from both consumer demand which has been very good doing in trucks and SUVs, but there is also inventory replenishment.

If you look at what the OEMs have in inventory there, the lowest I think I've seen in my time in Auto. So we're getting a double benefit from that, but that will take quite some time probably with the shortages for the inventory to get back up to 90 days or 100 days. Could that benefit us throughout our fiscal '22? Yes, I don't want to sit here and say that for sure. We really need to see what happens with the shortages and I know, you've got shortages not just in semiconductors, but -- and we have faced shortages really since the beginning of the pandemic. For the most part we've been able to alleviate them, but they're very real right now and we're seeing them affect everybody's results. Ron, I hope you want to add...

Ronald L.G. Tsoumas -- Chief Financial Officer & Vice President, Corporate Finance

Yes. I just think, I agree with those Don saying and clearly all the headwinds from the shortages in that are the top line and as you could see through the results, they also a double whammy effect in that affect our operations as well too. So a lot of what we're looking at next year will depend on that being satisfied and getting to a more normal run rate. And then, I think we'd probably be in a better position to fine tune that answer.

Donald W. Duda -- President & Chief Executive Officer

And the other thing I would say, Ryan, is obviously, we're very excited about our position in EVs. What we need to see how the programs materialize, do they stay on track, are they -- if the units are X, is it X plus or is it X negative in the end, and no one has enough history on that to say for sure. So we're a little guarded on what those volumes will be. You get on a truck program for Ford or GM, you pretty much know what the volume is going to be. It's much more difficult in EV. Now you -- we're going to get some volume because we're on the program, but we'll have to wait and see how that materializes.

Ryan Sigdahl -- Craig-Hallum Capital Group -- Analyst

And then just on the chip shortage and maybe I missed it earlier. Did you quantify or could you quantify how much that impacted your Q4 guide? And then do you expect that to be resolved this quarter, or do you think that will linger into this -- next fiscal year?

Donald W. Duda -- President & Chief Executive Officer

I think it's going to linger into our Q1 of next year. We have been told that perhaps by mid calendar year it may alleviate itself, but we've also had the caution that it may go on. We did not quantify it. There's a lot of moving pieces in the quarter. That's why we gave a large range. I can tell you that, let's go four or six weeks ago that our forecast for the fourth quarter was an excess of $300 million and which would have been a record quarter. So we're clearly being impacted in the fourth quarter, not so much the third quarter by chips. But we haven't quantified exactly.

Ryan Sigdahl -- Craig-Hallum Capital Group -- Analyst

Last one for me, I've asked this previously, but a little more directly, maybe your net cash position almost in net cash at this point. Nice debt repayment, but from the capital allocation standpoint, your stock valuation relative to earnings is lagged to peers for years. I guess, you guys are focused on acquisitions, which have come out a fairly sizable premium to MEI's valuation. Have you reconsidered a meaningful share buyback program versus more focus on acquisitions.

Donald W. Duda -- President & Chief Executive Officer

A very appropriate question. That is something that we are considering. We're now going to -- we're up [Phonetic] over $200 million in cash. Not likely to pay down much more debt, it is very inexpensive debt. There is some debt in Europe, we may repay. So now, but let me back up. We thought it was very, very important after doing the Grakon acquisition that we proved to the Street that Methode has a discipline to achieve the synergies and more importantly pay down debt. And we've accomplished that. And for the last, since the Grakon acquisition that was priority one. Now, where we're sitting today, we're ahead of where we thought we would be, largely because our teams did a very good job of taking cost out of the factories and dealing with tariffs and so on.

So now we will turn our attention to where do we put that cash to use. Do we do a stock buyback? That is certainly on our list. I won't give you a priority on it, but it is certainly something that we are considering. Having said that, we will -- we always look at acquisitions. Grakon was I think at first, there were some concern about it, but it clearly has put us in good stead in the commercial vehicle market and the EV market. And some of the EV wins we had were on what will be commercial trucks. And particularly, when you get into BDUs and PDUs. So I'm not going to say that we're not going to do an acquisition. So I'm not going to give you the order, but I can tell you the stock buyback is something that we would certainly consider.

Ryan Sigdahl -- Craig-Hallum Capital Group -- Analyst

Great. Helpful color. Thanks. Good luck, guys.

Donald W. Duda -- President & Chief Executive Officer

Thank you.

Operator

There are no further questions from the lines at this time. I would now like to turn the call back to Don for closing remarks.

Donald W. Duda -- President & Chief Executive Officer

Yes. And thank you very much and we'll thank everyone for listening to us today and have a good rest of the day.

Operator

[Operator Closing Remarks]

Duration: 35 minutes

Call participants:

Robert Cherry -- Vice President, Investor Relations

Donald W. Duda -- President & Chief Executive Officer

Ronald L.G. Tsoumas -- Chief Financial Officer & Vice President, Corporate Finance

Luke Junk -- Robert W. Baird -- Analyst

Ryan Sigdahl -- Craig-Hallum Capital Group -- Analyst

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