Methode Electronics, Inc. (MEI) Earnings Call Transcript

Good afternoon, and good evening, everyone. Thanks for taking the time to join the webcast today. My name is Rajat Gupta, member of the U.S. automotive equity research team at JPMorgan. Pleased to have with us the team from Methode Electronics: CEO, Don Duda; and CFO, Ron Tsoumas. In terms of the format of today's discussion, Don is going to start off with a slide deck and run through the company and the story, after which, we will dive into Q&A. [Operator Instructions] With that, thanks a lot, Don, for joining us, and I'm going to hand it over to you.

Thank you. Good afternoon, everyone. Thank you for joining us today. I'd also like to thank Ryan and the JPMorgan team for inviting us to the 2021 Auto Conference. On Slide 2, I will remind you that my statements today are subject to safe harbor protection. For a complete summary of our disclosures, please see Methode's filings with the Securities and Exchange Commission, such as our 10-K and 10-Q reports. Turning to Slide 4. Methode is a leading global supplier of custom-engineered solutions for user interface, LED lighting, power distribution and sensor applications in the transportation, industrial equipment, cloud computing and medical device end markets. Our fiscal 2021 sales were $1.1 billion. It was a record for Methode. Approximately half of our business is in North America [indiscernible] Europe and Asia, 3 growing regions solutions for us. From a solutions perspective, we view the business through the application of user interface, lighting, power, sensors, digital and medical. We operate the business via our Automotive, Industrial, Interface and Medical [ segments ]. Turning to Slide 5. Over the last 3 years, Methode has grown its sales at an annual growth rate of over 6%. Over this time frame, we have leveraged the increased volume and improved our portfolio mix to deliver EBITDA and an annual growth rate of almost [ 6% ]. We achieved these rates of growth despite the second half of our fiscal 2021 being impacted by [indiscernible] and other supply chain [indiscernible]. Turning to Slide 6. Methode is proud to be committed to ESG. Our robust government framework, [ commitment to ] safe operations and emphasis on clean technologies such as EVs resulted in favorable ratings from both Sustainalytics and MSCI. ESG is a long journey, and Methode is proud [indiscernible] On Slide 7, we have invested in our global footprint with our headquarters in Chicago, Illinois and vertically integrated manufacturing locations in North America, Europe, Middle East and Asia. This cost-effective footprint is strategically located in proximity to key [ geographical ] markets. On Slides 8 and 9, I will briefly describe the solutions and technologies that drive Methode's business. User interface products include switches, consoles and industrial remote controls that are leveraging growth drivers such as EVs and worker's safety. Lighting products include forward and rear lighting, ambient lighting and warning lighting that are benefiting from the transition to LED as well as a focus on driver and vehicle safety. Power distribution products include busbars, high current connectors and battery disconnect units that are benefiting from the significant growth in EVs and cloud computing. The [indiscernible] of our automotive [indiscernible] know-how is a key differentiator and competitive advantage driving our growth. [indiscernible] Sensor products include position, torque and load sensors that are leveraging growth drivers such as e-bikes and [indiscernible]. These products leverage our proprietary [indiscernible] magnetoelastic and any current sensing technologies. Digital data products include copper-based transceivers that are leveraging growth drivers, such as cloud computing and e-commerce, which require increased digital bandwidth. Medical, consists of our Dabir system for pressure injury prevention. The business is currently focused on long-duration surgeries but is also well positioned to be a solution for other applications, stemming from an aging population and long-term growth [indiscernible] trends. While this is a small percentage of Methode's overall sales, we believe it could be one of our fastest-growing businesses. As shown on Slide 9, solutions and technologies, [ ]our leverage across multiple end markets from automotive and commercial vehicles to data center and industrial equipment. Our ability to expand these solutions for multiple markets is a result of an inevitable and diversified customer base of brand name [indiscernible] Turning to Slide 10. We believe that Methode is an attractive investment given its exposure to key macroeconomic market [ trends ], such as electrification; its ability to leverage and scale our product portfolio; its world-class lean manufacturing, combined with the strategic footprint; and a strong cash flow and low net debt. We firmly believe that our [indiscernible] strategy is to design and engineer solutions, incorporating field-proven innovative technologies that provide differentiated value for our customers in key end markets. On Slide 11, our strategic [ priorities on ] diversification, growth and financial returns. Given the [ progress we have made ] diversifying our product portfolio into power, lighting and [indiscernible], capitalizing on market trends, EVs, commercial vehicles and cloud computing. With our technology solutions toolbox, we were able to address needs -- customer needs while increasing content per vehicle, penetrating non-auto markets and cross-selling into existing customers. This will allow us to drive organic growth. At the same time, we expect to continue to augment our portfolio through acquisitions that build on our successful business model and skill set. We believe these actions will further improve product mix and operational efficiencies and enable margin expansions. Lastly, [ with our ] lean manufacturing culture, we are targeting further improvements in working capital [indiscernible] Turning to Slide 12. With the burgeoning shift from internal combustion engines, vehicles to electric vehicles, Methode has a clear opportunity to grow our [indiscernible]. Building on our traditional scope of user interface solutions, lighting and sensors, we have [indiscernible] to significantly increase content per vehicle via power distribution solutions. Our scope on EVs can be more than double the content that we currently have on the general combustion engines [ for vehicles ]. For fiscal 2021, we reported that EV applications were 12% of our total [indiscernible], a healthy pipeline of [ EV programs visibility ] to project that this percentage will be in the mid-teens in fiscal 2022. Methode's combination of user interface, lighting, sensors and power distribution solutions is a winning formula in EV and positions us well for continued growth in this exciting market. On Slide 13, I would like to further elaborate on our footprint in EVs. [indiscernible] EV is generally divided into 2 parts: the top hat and the skateboard. The top hat is essentially [indiscernible] vehicle and various model to model. The skateboard is the chassis or a framework of the vehicle. As many of you know, this type of vehicle architecture is a game changer with EVs as can be standardized and leveraged across multiple models and platforms. On the [indiscernible] interface and LED lighting, along with some EV-specific solutions such as charging ports. These ports are fairly complex and include futures such as actuators and lighting, in addition to power [indiscernible] Turning to Slide 14. Here, we show a skateboard. This is where Methode is leveraging its unique combination of auto-grade manufacturing, our auto pedigree grade and our power distribution expertise to supply various busbars, connectors and battery disconnect units for EV OEMs. We're also gaining traction with sensor solutions for by-wire systems and battery monitoring. Our distribution is what [indiscernible]. Historically, our participation with power products and internal combustion vehicles was minimal. In EVs, it is quickly growing and has reached approximately half of our [indiscernible]. Consequently, Methode has a clear opportunity to incrementally grow our [indiscernible] transition to EVs. As I mentioned earlier, our content in EV can be more than double our content on an internal combustion vehicle. EV is a definite organic growth tailwind for Methode. Turning to Slide 15. In addition to revenue growth, our EV [indiscernible] commercial vehicle and cloud computing businesses to help drive our customer diversification. Both GM and Ford have been and are expected to be -- are expected to continue to be good customers that a [ field Methode rolls ]. In recent years, we have strategic [indiscernible] systematically for our own customer base. Our business outside of GM and Ford has grown to 2/3 of our fiscal 2021 total sales. Turning to our financial performance on Slide 16. Over the last 3 years, Methode has generated strong positive free cash flow. We have also delivered a healthy return on invested capital [indiscernible] cost of capital we believe is a key measure of our performance and effectiveness with the use of our capital in our operations. On Slide 17, our capital allocation history clearly demonstrates that we are focused on investing to grow the business through R&D, capital investments and acquisitions, all of which coming forward [indiscernible] capital spending over the last 5 years. This is balanced with our methodical approach to debt reduction and returning capital to our shareholders. In particular, we recently announced a 2-year, $100 million share buyback program and a 27% increase in our dividend. Our strategy is to deploy resources in the most [indiscernible] manner and use our capital investments to drive growth, improve operational efficiencies and create value for our shareholders. Our relentless focus of generating cash will continue to support this strategy. Turning to Slide 18. Since taking on debt to finance the Grakon acquisition, we have systematically delevered the balance sheet. Our net debt [indiscernible] On Slide 19. When it comes to M&A, our framework is relatively straightforward. We look for companies that [indiscernible] strategy and can leverage our technologies, our path to market and our manufacturing capabilities. This disciplined approach has served us well, and we will continue to employ it. In summary, on Slide 20, we believe that Methode is a very attractive investment, given the exposure to key macroeconomic and market trends, such as electrification, its ability to leverage and scale [indiscernible] product portfolio with world-class lean manufacturing [indiscernible] strong cash flow and low net debt. With that, I thank you for your interest. Brad (sic) [ Rajat ], I think we can now move on to the Q&A portion.

Great. Thanks a lot. Thank you, Don, for that presentation. I think we did have some trouble with the audio, but I'm hoping investors got most of it. Just to start off, I know, I appreciate your -- in the prior period and you'll be reporting earnings soon. But could you give us just a quick update on just what you're seeing on the ground? How has demand been? How has production ramping up? Everyone in the industry is being impacted by global supply chain issues. Maybe you can talk to us maybe at a high level, just some of your exposures, the impact of the business. What kind of proactive actions are we taking to address? And then I have a few follow-ups.

Sure. We are [indiscernible]. We can't comment on the quarter for us, but what we had said previously, and I think that continued, is that there are shortages or [indiscernible] shortages. But what has been lacking is a need in the industry for [indiscernible] to remain very aggressive. And if you look at the inventory of the OEs, it's way down [indiscernible]. Methode is fortunate that we are on [indiscernible] probably get a higher share of allocation of chips from the automakers because that is their best [indiscernible], and that has helped us. But every day, there are shortages in not just chips but also in [indiscernible] components a couple of port congestion a long, long time ago, water from Asia to the U.S. So those are all hampering companies [indiscernible]. I think our team has done an excellent job dealing with that around the world. It has increased our [indiscernible] on the cost of logistics, there's no question about that. Revenues, up in the first quarter, were good. They were in line with what [indiscernible] first quarter with fourth quarter. What we have projected, they could have been higher if the OEs were not constrained by [indiscernible]. But our margins suffered through from the logistics. Now that will eventually improve and the margins will return, but that has been a drag on our earnings for [indiscernible]. So in third quarter going into the fourth quarter, I think Ron can correct me. I think fourth quarter was actually tougher than the third on that. I don't know if there's anything you would add to that.

No. I mean -- yes, I mean, we're blessed from the perspective that we're on the high-selling vehicles, high-profit margin vehicles for some of the OEMs, which has really helped. And the teams have done a great job working with the OEMs, in many cases, during resin shortages, having things flowing in from all over the world to partner and keep production moving along. So -- but clearly, as Don had mentioned, margins are certainly going to be negatively impacted. We're -- and we anticipate, until the semiconductor shortage resolves itself that we'll be under continued pressure. And certainly, port congestion is another thing -- another residual impact that we're wrestling with and consumes working capital and things of that nature. So -- but the team is doing a really -- a good job in mitigating it from all sides.

Got it. Got it. Great. That's helpful. So yes, maybe just shifting gears a little bit to the electrification story here. You provide some details on some new programs and launches. Can you discuss some of the most important ones and the largest ones in the near term that could have a material impact to the business, maybe in terms of growth or like content? Anything you can share on that front?

Generally [indiscernible] customer specific. So let me say this. When we look at future revenue potential, it is a blend of the established OEs like a Volkswagen, [indiscernible] in their product offering in EVs [indiscernible] well positioned [indiscernible]. And also, we also look to [indiscernible], and some of those start-ups are well funded. And maybe too soon to tell what impact they have. It's a [indiscernible] by the established OEs and the start-ups into EV that [indiscernible] double-digit sales versus sales from EVs, which is up significantly from a year ago. Now I should mention that our first products in the EV, I think we shipped in 2006. We've been doing it for quite a while. It's only been the last couple of years that it's becoming significant. I think the drivers are really across the board for us. And we talk about growing content per vehicle. We have -- you can't say we have a clean slate, but we have -- there's less established suppliers in EVs and then maybe in internal combustion vehicles. And so where we may not have been able to get into a certain maybe user interface or another area of the vehicle, we can with EVs. And what opens the door for us over there are [indiscernible] and so on. So there's just a number of [indiscernible]

Got it. I think, Don, we're still having a bit of a trouble with your audio. So maybe if Ron can take the next couple of questions and whether...

Let's do that.

The audio, that might be helpful. Ron, I'm not sure, like we caught a lot of what Don just said. So if you could like reiterate some of those comments, that would be really helpful.

Absolutely. We're well positioned in the EV space for a couple of reasons. First, we have a long many-decade pedigree in power solution products. We've been building busbars and high current-carrying power distribution systems for 30 to 40 years. You marry that with our customer relationships and path to market that we have in the auto space, and that gives us a really good avenue or a quick avenue into the OEM. And as we look forward to -- and you couple that with the LED lighting and the user interface, we can now go to any OEM and provide a comprehensive solution to top hat and skateboards requirements with our product solutions. And our global footprint really helps with that, too. In Malta, Egypt, China and now in Mexico, we're developing and increasing our power manufacturing capacity into all facilities that are auto hardened and auto standards. And we're excited particularly about our Egypt facility because it's in close -- relatively close proximity to the European continent where the EV growth and the exposure is higher than in other parts of the world. And it's a very [ excellent ] workforce [indiscernible] cost of labor. So we get in favorable tax thing. So you put all that together, and we should be [indiscernible] to address the EV opportunities. And the last thing I'll say to that maybe is that it's mostly additive to us. Other than -- since most of the upside is on the power side, we have a relatively small amount of business in the internal combustion engine, transmission, the powertrain. So there'll be a slight cannibalization but nowhere near the opportunity that we have to add volume to the skateboard. So we feel that we're well positioned to take advantage of this trend.

Got it. And maybe if you could talk about some of the content and your exposure to these new upcoming public electric vehicle manufacturers. You've talked about Tesla in the past. Maybe you could give us a sense of what the opportunity is at like Rivian, like are there others, other major up and comers that you're involved with that you may have content on. Just curious, your electric vehicle mix is -- versus like some of the other suppliers that we cover, your electric vehicle mix is much higher as a portion of your business. And just curious like how fast that level of your exposure to electric vehicles can grow as these new upcoming electric vehicles start selling vehicles at volume.

Sure. We're certainly in with the more established ones, but we are in with the Rivians and some of the upstarts as well. And we feel it's important to spread your seat and do with both. So obviously, we're careful on how we conduct our business and do that. But yes, we're definitely in a good position with some of the start-ups on a go forward basis. So we're -- we've done a good job doing all that as well.

Got it. Great. And you definitely have like a huge non-auto exposure. I believe it was like 40% of your revenue, maybe higher in terms of profit. And power distribution seems to be like the biggest exposure there, correct me if I'm wrong. Can you give us a sense of the outlook in that part of the industry? What kind of customers should we be tracking? Is it mainly like some of these cloud computing companies, hyperscalers, like just track their CapEx and your business probably grows with that CapEx? Just help us understand the outlook there and the opportunities on that front.

Sure. Let me start with saying in 2018, 80% of our sales was Automotive. And in 2021, that was down to 69%. And virtually, all of the shift went into our Industrial segment, which is our highest-margin segment, which consists of the power distribution that goes into both vehicle electrification and in data centers, as you just mentioned, our radio remote controls business in our commercial vehicle lighting business. So that segment has gone from being 26% of sales to higher than that now but at great margin. As you noticed in our fourth quarter, the Industrial profitability operating income was closer to the Auto side as well. So we like where we're positioned with those. We can't name all the customers from a cloud computing standpoint that we're in. But we're within -- we're with some leaders to be sure. And as that grows, we think that we're well positioned there to continue or at least participate in the growth that they're going to have.