Methode Electronics Inc (MEI) 2003 Q3 法說會逐字稿

Good morning. My name is Kerry and I will be your conference facilitator. At this time I would like to welcome everyone to the Methode Electronics third quarter earnings conference call. All lines have been placed on mute to prevent background noise. After the speakers remarks, there will be a question and answer period. Press star and the number 1 on the telephone keypad. To withdraw your question, press star and the number 2 on your telephone keypad. Thank you. Mr. Duda, you may begin your conference.

Thank you. Good morning, everyone. We apologize for starting late. We had difficulty getting linked up this morning. Thanks for joining us. Most of you should have received your earnings. If not, you can obtain a copy from the Investor Relations page on our website.

With me is Douglas Koman, Vice President of Corporate Finance, Bob Kuehnau the Treasurer and Controller. Also Joey Iski, our Director of Investor Relations who joined us from Thomas Financial earlier this year. You can call if you have questions or need additional information. She can be reached at the number reached at the contact information section on our press release. We'll ask you to read the Safe Habor for us.

Thank you. Certain statements in this conference call dated February 27th, today, containing information on Methode's third quarter reporting period for fiscal 2003 and offering guidance for fourth quarter and full year reporting periods for fisical 2003 are forward-looking statements that are subject to risks and uncertainties. The company's results will be subject to same risks applied to the automotive, computer and telecommunication industries such as general economic conditions, interest rates, consumer spending patterns and technological change.

Other factors which may return different results include market growth, operating costs, currency exchange rates and devaluations, delays in development, production and marketing of new products and other factors set forth from time to time in the company's form 10-K filed with the Securities and Exchange Commission. The forward-looking statements in call are subject to the Safe Habor protection provided under the securities law.

Thank you very much. Doug and I have comments today and afterwards we'll be happy to take your questions. Methode third quarter continues to exhibit solid growth in both revenues and net income. This is the third consecutive quarter we reported year over year growth in both sales and net income. Excluding the warranty reserve taken in last year's third quarter, net income has increased year over year by 31% for the third quarter and 33% for the first nine months of fiscal year 2003.

I should note that these gains would have been larger if not for currency losses due to the declining dollar. Our automotive business unit has remained strong and increased year over year sales by 3%. This increase was primarily the result of new business at our North American automotive facilities, new product rampups for Ford and Chrysler contributed to the increases. In our European facility in Malta, increase sales came from Ford Motor company.

Further, we are pleased to announce that for the second year in a row, Methode's Malta facility has been named by general motors as supplier of the year. In Scotland we were awarded business for an electronic steering lock Meckenition for the XK 8. And asked to quote this product on additional platforms. The five-year program which measures in calendar year 06 could reach over 50,000 units. While not significant in revenues, it represents a new area for Methode.

In general we are pleased with third quarter results despite the lackluster world economic environment and the uncertainty of war. In the quarter, we also had disappointments from our optical group. Sales fell sharply as a result of technologies business unit in Texas. A decline in sales almost 25% over the same quarter last year. This represented a decrease in Methode's before tax income of propositionally half million dollars for the quarter.

Also during the quarter Methode development lost certain business to chinese suppliers as electronic customers further reduced product costs. As a result, we have instituted a plan of action plan, it has been included in the fourth quarter guidance. In our products groups, sales are up slightly with modest earnings contributions. Continues to be difficult to forecast future results as customers are ordering product on an as-needed basis providing virtually no visibility for future requirements. On a more positive note as we previously announced, Methode completed the acquisition of our exclusive automotive sales representatives, ABA.

I want to take this opportunity to welcome the former KB employees to the Methode family. Regarding the planned tender for Methode B shares, filed with the SCC on February 21. Any additional commentary on my part regarding the tender is not appropriate at this juncture. Moving to the fourth quarter, we are forecasting sales between $86-91 million and our forecasting net income of 16-17 per share. For the full year, Methode forecast sales between 355-360 million with a net income between 58-59 cents per share for the 2003 fiscal year.

As we move through our fourth quarter, we will finalize development of Methode's fiscal 2004 plan and share with you our projected forecast for the first quarter and for the full year during our next earnings release. At this point, I will turn the call over to Doug who will provide additional financial commentary.

Thank you, Don. Good morning, everyone. Like to provide some segment detail. In the third quarter reported net sales for the electronic segment was $83.4 million versus $66 million last year. The numbers for last year versus the numbers I just provided include customer-paid tooling which primarily is due to the automotive OEMs up 7.9 million and 1.7 million for fiscal 2003 and 2002 respectively.

When customer-paid tooling is excluded, the increase in sales for the electronic segmant, sales for the quarter was 17%. As Don indicated the sales increase in the electronic segment was driven by the adjusting for the customer paid tooling, sales growth for the automotive business was up 20% in the third quarter.

Additionally if you look at revenue growth for the automotive group without the positive impact of the 2001 acquisition of automotive safety technologies, the growth rate was 17% on our base automotive business. Gross profits in the electronic segment were were $18.6 million compared to $8.4 million last year. This is an improvement of 22.3% from 12.7%. The optical and other segments reported combined sales of $8.7 million this year versus $8 million last year. Gross profits for these segments increased to $1.1 million compared to half a million in last year's quarter.

For the nine month period, the electronic segment had net sales of $243.4 million versus $202.1 million last year which included customer-paid tooling sales of $15.8 million and 3.5 million in fiscal '03 and '02 respectively. The increase in sales for the electronic segment was 15% when customer-paid tooling is excluded. As in the quarter, this nine-month increase in the electronic segment was driven by our automotive business that is reported a 25% increase in sales to $199.7 million up from $159.7 million in last year's nine-month period. Adjusting for the customer paid tooling, the sales growth for our automotive business was 18%. When further adjusted to eliminate positive impact of automotive safety technologies, the growth rate was still an impressive 15%.

Gross profits for the electronics segment were 52.1 million for the nine-month period. This compares to 32.9 million last year. An improvement in gross margin to 21.4% from 16.3 last year. The optical and others segments reported combined sales of $25.5 million versus $32.6 million in last year's nine-month period. On these lower sales volume, the gross profits for these segments declined to $4.1 million from $5.8 million last year. For the nine months, the earnings before interest taxes depreciation and amortization was $33.5 million.

Our annualized return on capital was 8.1% for the nine-month period. Capital spending was 6.4 million for the quarter and $15 million year to date. Full year capital spending is expected to be 19-20 million for the year. This is higher than our previous guidance because of our decision to upgrade and bring additional molding capabilities in-house at our Illinois facility.

Lastly, depreciation expense was 10.9 million and amortization was .9 million for the nine-month period. With those brief comments, I'll turn the call back over to Don.

Thanks, Doug. Kerry, I think we are ready to take questions.

At this time, I would like to remind everyone, if you would like to ask a question, please press star and then the number 1 on the telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Lori Thourow with Robert W. Baird.

Good morning.

Good morning.

I have a couple of questions for you. On the other expense line that was different than what we were looking for, what's behind that expense there? Is that the part of the KB acquisition or currency?

If you're looking at other net, the loss for the quarter of just about $1 million?

Right.

That is from currency losses.

Okay. And then just to follow up on the KBA, did you disclose the final purchase price on that?

No, we have not disclosed that.

On the electronics mechanisum for Jaguar, you mentioned that your [ Inaudible ] is that primarily North America, Europe or both?

Primarily in Europe, though we've done presentations for the North American OEMs, primarily Chrysler and Ford but primarily in Europe.

Okay.

And that's for an IP-mounted ignition.

Okay. And then you mentioned that you're taking actions to prevent losing business to your chinese competitors that may have a little bit of a lower cost and that you put that, that's been adjusted in the fourth quarter guidance, is that going into the SPA or other item?

What I was referring to there, the business we lost when we look at manufacturing in China or Malaysia, we chose not to attempt to retain. What we have done in our island facility is we are consolidating that facility, reducing the square footage and done some reductions there and that facility will do more prototype specialty assemblies and act more of a sales office out of China and the costs associated with that restructuring we included in our fourth quarter guidance.

Okay. And then there was some good working capital improvement especially in the receivable side, looking sequentially and year over year, was there a big action in there or focus on your part, is this sustainable? Looks like receivables came down in terms of DSO's quite a bit.

We did see improvement in the sales outstanding. I can't say that it's sustainable but obviously we try to work on matters and balance sheet very hard and where we can improve, we improve it. That's the best way to answer that.

Okay. Great. That's all I have for now. Thanks.

At this time there are no questions. I'm sorry, you do have a question from Steven McBoil with Lord Abbot.

Good morning.

Good morning.

Perhaps first to start with the KBA acquisition, can you elaborate as to whether that is a net cost benefit now that you're doing that inhouse, perhaps with the overarching strategy is and to the extent it is inhouse now, do you see this as a larger revenue opportunity going forward?

Okay. KBA was our exclusive sales representative from worldwide, they're not a revenue generator per se, they facilitate the sales that ultimately generated. There were a number of reasons for that acquisition. First, to better manage our customer relations in the introduction of new products as the OEMs continue to push down more and more engineering to the suppliers, new programs has been crucial to the new launch and often whether you're going to Mack money on a product is determined how efficient you engineer it and launch it.

Secondly KBA was focused on Ford and Chrysler. While we commend their effectiveness to these accounts, it's important they diversify the customer base particularly in the transnational OEMs. And to get to your question directly, we will immediately begin to save a minimum of $2 million in cash per year that won't have an immediate effect on our P&L as we amortize the purchase cost.

And it sounds as if perhaps though now that the effort is in the house, there may be an opportunity with respect to the foreign OEMs, is that the case?

That is in fact the case. We have already taken actions to redirect some of our efforts in that area.

And who would you be specifically targeting there?

Initially Honda and Toyota.

Okay.

And we already do business with Mitsubishi and will try to leverage off of that, also.

Okay. And just quickly to get this out of the way, the foreign currency issue, is there any hedge position involved there?

We've been looking at that, obviously. What we've done during the quarter is we have converted one of our business units in Ireland, we changed their functional currency to the dollar so that will eliminate any income statement impact going forward. The biggest exposure we have is to the [INAUDIBLE] because that's a restricted currency, it's a little more difficult to work with as far as the hedging strategies that you could do, for instance, for the euro. So we are still working on how best to protect the income statement going forward. We are looking at that. Prior periods have have benefited from gains and with the weak dollar and I think the uncertainties of war, we've just seem some problems this year.

And so if you look at this given you've converted Ireland to the dollar base, is there, I guess, on a proforma basis, looking at it that way, what would have been the foreign currency?

Probably on that business unit alone, we could have eliminated about $300,000 of loss there just changing the functional currency at the beginning of the year.

Okay. And just turning maybe to the auto side of the business. Can you just elaborate as to the opportunities there that you may have in GM. I know you were bidding some business there. It sounded like there was a potential business opportunity there, and also perhaps in Japan as well.

Okay. We are in the middle of bidding on GMs 900 program, that's 8 switch families. That quotation is still open. We made it to what we believe is the final round, but I don't have any other news to report other than we're still in the hunt for that. And we are overseas, we are meeting with one of the transnationals regarding the Glockspring business and I don't know if I want to comment too much more on that.

Okay. And just more broadly, would you describe the, quote, activity opportunities on that side continuing to be positive in outlook?

Yes. Yes, I would.

Okay. And then, perhaps the non-auto side of the business. You touched on the fact that optical sales were down 25%, can you just give us a sense as to where you think, perhaps, given the current bidding that may be taking place there, what you would expect on that side of the business going forward?

The major portion of our optical business is in the insulation cabling for data centers and that had slowed down a bit and that's what affected connectivity and not a tremendous amount of visibility. It is capital spending for the customers. If they decide to upgrade and open another data center, business will increase. We have a good forecast from connectivity for the fourth quarter; however, I remain cautiously optimistic about that. Again, it is not as much visibility as we see in auto.

And what would be the dollar in revenue really to the optical business today?

In revenue for the quarter, our optical would be at $4 million and four nine months we'd be at about $14.2 million.

Okay. And then more broadly on the EMT group or non-auto, as I understand it, there's eight businesses there, are they all profitable today? Where do you stand on that?

The group as a whole is profitable, but we had two of them that were slightly in the red. As usual we're taking necessary actions to correct ha.

And which two are those?

I don't know if we normally get into that much.

Fair enough. And then just with respect to the overall group.

They know who they are. That's what's important.

That's what's important. The book to bill for the group itself, does that remain over one?

For the non-auto?

That's correct.

I don't know that I have that. That's one of the questions we didn't come prepared to answer, Steve.

I can follow up on that. And the sales force on non-auto, is that relatively stable today? Any issues on that front?

On the sales force?

Yep.

Not that I know of. At the mixture of direct account managers and representatives, I don't believe there are any issues there.

And the business that you're bidding on there, can you just talk to the margin or profitability benchmarks that you're using when you accept business as those opportunities come even though they are few and far between these days?

Certainly. Historically Methode has focused on applications specific, products and more niche products where we can apply our engineering and global resources and in return for a pretty hefty margin. So we target a minimum of 20% on new business. Now in connected products, that is more of a commodity and that produce primarily comes out of the far east now so those margins aren't as lucrative.

But as we move forward, rather than bid on one connector, we try to bid the whole project. For example a PCMCIA card, we have the capability to provide the connect, the card itself, we can deliver a turnkey product to the customer. When we start to do that, our margins improve and we tend to shy away from being a pure play connector provider and go up the food chain. When you do that, particularly if you're in more of a niche situation, not trying to compete with the main stream there, you'll see better margin. That's been their successes over the years. When they get away from that and try to play in the commodity market is when the margins erode.

Okay. And just maybe to shift back to the auto side, one question I didn't ask, you're in the midst of transitioning more towards on the manufacturing side, a sell based approach, can you just give me a sense as to where we are in that transition? Are we early innings, have we seen the full potential of the margin improvement from that initiative? What would you expect going forward?

We're quite a ways through that in converting to sales. There's still some cells in Carthage yet to be converted. We're really moving on now to lean manufacturing practices and trying to take crossed out [ Inaudible ] starting to mature in that sense and now looking to what's the best steps we can take, value string mapping and et cetera. Also we are focusing heavily on material costs that we made progress in but certainly room to improve.

What specific materials would represent opportunity going forward?

Oh, just a wide variety of molded components, assembly, about 42-43% is material cost in automotive? Ideally like to see that under 40, and we've made progress getting a percent out.

That's just across the board. There's room for improvement.

But, Steve, the capital spending on the molding projects that I mentioned earlier, that addresses some of this. We bring that in-house and eliminate having to buy it outside.

And that's on large components where your savings, some inhouse savings and probably better efficiencies from it and save on transportation.

I understand, okay. And what would the revenue have been in the quarter with regards to ACI?

I think we talked about ACI in general terms before. We haven't broken that out?

If you haven't, that's fine. Maybe you could elaborate on as I understand the regulations going forward here. Perhaps what your view is, interested in your perspective as to what you think the requirements are going to be in the '04-'05 time frame? I understand the lobbyists are lobbying hard and interested in what you're hearing of late.

That's a good reduced the requirement from 35% down to 20. They have not reduced ' 05 which is sitting at 65% and also get credit toward your '05 as I understand it toward your requirements if you exceed your '04 requirements. We've seen only one reduction. We could not plated the change when we analyzed the acquisition. We didn't believe from the beginning it would stay at the 35% and that's the end of what we know about that right now. I don't know that the 65% will hold and we certainly again in our projections contemplate something less.

All right. Okay. And, again, you're not limited to sell elsewhere outside of Delphi, is that correct?

No, we could sell to someone else.

Okay. I think that's it. Thank you very much.

Thank you.

You have a follow-up question from Lori Thourow from Robert W. Baird.

I just wanted to talk more about the steering mechanism business you've got the contract for and working on. Can you give me more detail what's involved in that?

Sure. The requirement has been for quite some time to lock the column as you turn off the ignition and leave the vehicle, there's a mechanism that will lock the wheel. Usually tied to the ignition cylinder on the side of the column. Once you from a styling standpoint move the ignition switch to the instrument panel, move it off the column, you still need the mechanism to lock the column.

So what our engineers have developed over the past year or so it really a electronic mechanism that in conjunction as you turn off the ignition switch, it will move to lock the column and certain criteria that the automakers have and has to be able to withstand certain blows from a hammer and all the things you do to try to prevent theft. As the styling has changed it represents an opportunity for us to solve that problem for the automakers. That's not unique to Methode. There's other people that do that. We were successful in landing some business at jaguar, we'll try to leverage that as we go forward.

And what do you see as the trend of vehicles having the ignition switch moved from the column to the IP? Is that an up and coming trend? Do you have a lot of visibility there?

Seeing it more on higher-end vehicles. Not seeing it on, you know, truck platforms and things like that. I don't know if we have that much visibility with the styling guys.

All right. Okay. Thanks.

Thank you.

You have a follow-up question from Steven McBoyles from Lord Abbot.

With regards to the business you took a pass on in China and Malaysia that affected the Ireland facility, can you explain why that business was not attractive? Why obviously you passed on it? Outside of obviously economics.

It really is an economic decision. Where do you want to spend your engineering resources and SG&A money in support of business that is lower margins? You'd rather redirect that to higher margin business. It was really an economic decision.

Okay. And the costs that were incurred in the quarter with regards to the Ireland facility, can you quantify that?

In the fourth quarter, we had a couple hundred thousand dollars in the forecast for that. Less than a quarter million, I believe.

And in the past quarter?

It's contemplating our fourth quarter guidance.

No impact. Great, thank you very much.

Thank you.

Once again, I would like to remind everyone, in order to ask a question press star and the number 1 on the telephone keypad. Your next question comes from Ken O'tool with Delta management.

A couple things. Actually, could you reiterate, I missed this earlier, could you reiterate the impact of currency shifts into the quarter?

Sure. In the quarter it was $1 million. And nine months it was $2.2 million.

And what do you anticipate for the fourth quarter?

In our guidance, I don't believe we're really anticipating significant movement in the dollar, so that could affect our guidance as you see.

A big swing. We made adjustments for the currency.

Okay. Are you seeing, obviously well documented that a lot of the auto guys have some inventory on the lots. Are you seeing shifts from them at this juncture in time? The product flow that indicates whether they are changing their approach?

Our releases for March and April have been quite good.

Good.

We do monitor inventory levels and something that the automakers do well, very quickly is adjusting. In terms of near-term releases, it has done quite well.

Okay. Good. In terms of you probably look at the data as well. Are you seeing the inventory levels being worked down with the incentives and stuff?

What I've seen and haven't looked in the past week, I've seen they are stable. Haven't seen any huge swings. But I also look at what line shutdowns the OEMs have.

Sure, you get a better view from what they are doing than the end market, I'm sure.

Our releases and what we know in shutdowns or overtime tend to guide our forecast more than anything else.

Sure. Certainly near term that makes sense. Are you able to and have you seen anything going on in terms of raw materials? Obviously where oil is at some point, that probably impacts resins and I don't know if you have the ability or to what extent you have the ability to hedge that exposure.

We have the annual contracts and there are more to that but nothing yet.

No big swings with the contracts. Okay. Good. One thing I tried to get data on it and trying to fill in the blank because I'm seeing this a lot and trying to revisit it, do you have a pension internally. You've been around for a while, and you may, and what would have been the shifts through the income statement on the pension?

Tim, we don't have any pension liabilities. Our 401(k) is a combined contribution.

It's virtually all 401(k)?

Virtually, yes.

That's why I didn't find anything about it. Thanks, very much.

If you would like to ask a question, press star and the number 1 on the telephone keypad. At this time, there are no questions.

Kerry, we will thank everyone for joining us today on their questions and that will conclude the call.

This concludes today's conference. You may now disconnect.