Methode Electronics Inc (MEI) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Methode Electronics, Inc. second quarter fiscal 2005 results conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded. Certain statements in this conference call are forward-looking statements that are subject to certain risks and uncertainties. The Company's results will be subject to many of those same risks that apply to the automotive, computer, and telecommunication industries such as general economic conditions, interest rates, consumer spending patterns, and technological change. Other factors which may result in materially different results for future periods include market growth, operating costs, currency exchange rates, devaluation delays and development, production and marketing of new products, and other factors set forth from time to time in the Company's Form 10-K and other reports filed with the Securities and Exchange Commission. The forward-looking statements in this conference call are subject to the Safe Harbor protection provided under these securities laws. I would now like to turn the conference over to Mr. Donald Duda, Chief Executive Officer and President of Methode Electronics. Sir, you may begin.

Thank you, Dan. Good morning and thank you for joining us. With me today is Doug Koman, our CFO, and Bob Kuehnau, our Treasurer and Controller. Joey Iske, Director of Investor Relations, is also on the call. Both Doug and I I have comments and afterwards we would be pleased to take your questions.

For the second quarter of Methode's 2005 fiscal year, we're reporting a 9 percent increase in sales year-over-year, net of tooling sales. As we indicated in our press release, included in our results was a 2 cent charge for the impairment of assets related to the closure of our manufacturing facility in Singapore and for the cost of relocating automotive molding tooling from an insolvent supplier. Even with these charges, cost of goods sold as a percentage of sales was reduced 1 percent compared to last year's second quarter. This is a a good bellweather of the improvements coming from our manufacturing operations, despite the severe price pressures. Doug will provide you more detail in his discussion.

The results for the quarter are in line with our expectations, and for the first 6 months we have increased earnings per share a penny to 31 cents over the prior period. As expected, revenue increases were primarily from our AST and European automotive groups, plus increased sales from our dataMate division, along with continued solid sales from Network Bus.

In the second quarter automotive sales grew, net of tooling sales, approximately 9 percent year-over-year, while Network Bus increased just over 30 percent. Our automotive group in Scotland continues to make progress and has completed the consolidation of all manufacturing into their new facility. You may recall we purchased a renovated manufacturing facility from Polaroid(indiscernible) Corporation to support the growth of this business. This consolidation, coupled with more diligent manufacturing practices, has favorably impacted production yields and shipment consistencies. This has been particularly noticeable on the high-volume (indiscernible) line which is now producing in excess of 10,000 switches per week. While the ramp up of this automotive plant has been a drag to earnings, we anticipate Scotland to reach modest(indiscernible) profitability in our fourth quarter and obtain solid profits in fiscal 2006.

In North America, the implementation of lean manufacturing tools or what we refer to as Methode Automotive Production System, continues to reap benefits. We realized quarter-over-quarter improvement in quality, delivery, labor, efficiencies, equipment downtime and scrap. For example, PPM to our customers improved from 16 to 12 PPM, equipment uptime improved from 85 percent to 91 percent, and scrap improved as a percent of sales from 0.82 percent to 0.75 percent. It is important to stress that these improvements, while significant, have been to a large part offset by price reductions.

Nonetheless, Methode is evolving into a world-class manufacturing organization which will serve us well as we evolve beyond automotive switches. To that end, we are leveraging our expertise in switch, sensor and HVAC technologies to develop Medtronic (ph) assemblies such as the center console for Aston Martin (ph)(indiscernible) launched this quarter. Center consoles, or center stacks, often include controls for engine starting, in-car entertainment and communications, heating and air-conditioning and driver information.

Over the coming years these Medtronic systems will assist Methode in transitioning from value-added switch supplier to a true subsystem integrator thereby enhancing vehicle content values and overall profit margins. For the future, beyond model year 2010, we continue to evaluate new Automotive Technologies that we believe are important to our product offering. Some of these include advanced switch (indiscernible) such as field effect switching, advanced display technologies such as organic light emiting diode displays or OLEDs, as well as driver positioning and alcohol impairment sensing.

Moving to the nonautomotive side of the business, Methode's Singapore facility is in its final stages of shutting down with the last shipment of equipment scheduled to ship to China in mid-December. Shanghai is ramping up production and currently over 60 percent of the equipment transferred has been installed and is in production. Like our Scottish automotive operation, Asia has been a drag on earnings. We expect this to continue through the end of this fiscal year with modest profitability in fiscal 2006. As we gain more business in Asia, we anticipate our China operation will become a solid income contributor.

The RJ45 copper transceiver from dataMate Division, continues to gain market share. An interesting side note is that a year ago our dataMate business was posting red ink and now is in double-digit ROS. We are pleased with the progress and congratulate them on their turnaround. We do anticipate increased competition as competitors gain customer certification, however, our largest OEM customer is expecting orders to increase in the coming new year. We will of course maintain a close watch on this business to retain our market share and profitability.

While a smaller contributor to Methode's overall sales, business remains strong for our Network Bus unit. They had impressive sales growth of 30 percent and profits were up 33 percent for the second quarter over the prior period. The outlook looks very positive throughout the balance of the fiscal year as demand remains strong from the computer, transportation and military markets. The challenge for this business unit moving forward is to continue their sales growth in conjunction with margin improvement as they are not necessarily immune from the China migration.

Looking ahead, Methode expects to achieve third quarter fiscal 2005 sales between 80 million and 85 million, and earnings per share in the range of 10 cents to 12 cents. We have modified and tightened up our full year sales guidance to between 370 million and 380 million, as we anticipate weaker vehicle production schedules and slightly reduced tooling sales. Earnings per share remains between 65 cents and 70 cents for the fiscal year. At this point, Doug will provide additional financial commentary.

Thanks Don. Good morning everyone. Let me start with sales activity for our 3 segments; all numbers will exclude customer tooling sales.

Our automotive businesses within the electronics segment had second quarter net sales of 74.4 million compared to last year's second quarter of 68 million. That is a 9.4 percent increase year-over-year. For the 6 month period, the automotive businesses had net sales of 139.1 million compared to 126.4 million last year. That is a 10 percent increase. The year-over-year improvement is primarily due to increased seat sensor sales at our automotive safety technologies unit and new launches at our European automotive businesses. The nonautomotive businesses in the electronic segment had second quarter net sales of 12.2 million, down slightly from 12.7 million in 2004. For the 6 month period, the businesses had sales of 23 million in fiscal 2005, compared to 23.1 million last year.

For both the quarter and 6 months, we had increased sales of dataMate Products, small form factor pluggable line of copper transceiver products. The balance of the businesses in this group were down slightly year-over-year and it is worth noting that last year's sales included about 500,000 and 900,000 for the quarter and the 6 month period, respectively, from our Ireland manufacturing facility that was closed in the third quarter last year. The businesses in our optical segment had sales in the second quarter of 5.6 million compared to 5 million last year. For the 6 month period, sales were 9.4 million compared to 8.8 million last year. Sales in the current quarter included approximately 1.6 million for an infrastructure project that we consider a onetime event. Also, last year's sales included approximately 1 million for the quarter and 1.5 million for the 6 month period from our UK manufacturing facility that was closed in the fourth quarter of last year.

The Bus bar operation and testing labs in our other segment had second quarter sales of 6 million which is up a million from last year's quarter. The 6 month period, sales were 11.4 million. This is also up 1 million for the same period last year. As Don mentioned this is attributable to increased Bus bar sales.

Looking at other items on the income statement, as we detailed in our earnings release, second quarter selling and administrative expense was 12.8 percent of net sales compared to 11.3 percent last year. The increase is primarily due to the amortization of the restricted stock awards, our initiatives to comply with the requirements of Sarbanes-Oxley, increased sales costs at our domestic connectivity business and increased automotive research and development spending. We expect the run rate for selling and administrative to be about 13 percent for the full year. Cost of products sold improved as a percentage of net sales and would have been greater except for the cost related to the transfer of manufacturing from Singapore to China. The expenses relating to transferring automotive tooling from an insolvent molder.

Other income is down primarily due to winding down of a joint venture which manufactures a multifunction switch for Chrysler, and to adjust for automotive design engineering fees, we feel will not be collectible. The year-over-year change in other net is related entirely to foreign currency.

Some balance sheet and cash flow items worth noting. Inventories are up from year-end for a few reasons. Our automotive businesses are building inventory in anticipation of their 2 week shutdown in December. Automotive is also building inventory in advance of taking down some lines to incorporate lean manufacturing initiatives. That is part of the Methode automotive production system that Don mentioned earlier. The domestic automotive businesses are still confident, however, that they will meet their fiscal 2005 goals to reduce inventories by 10 percent. Our dataMate unit increased inventories to support the slightly longer leadtimes and increased sales for its RJ45 transceiver. Because of this, inventory turns are at about 8.6 times or about 42 days on hand. Capital spending was 4.5 million in the quarter and 10.3 million for the 6 month period. That is compared to 3.7 million in last year's second quarter and 7.4 million for the 6 month period last year. The increase is primarily due to launches at Automotive Safety Technologies and at our European automotive facilities.

For the full year we expect capital spending to be about 20 million. Accounts receivable turns are at about 6 times or 61 days outstanding. This is slightly higher than our historical rate and is due to more sales at our European operations where payment terms can be in excess of 90 days. EBITDA for the quarter was 14.6 million and 26.5 million for the 6 month period which is 14.3 percent of net sales. Don, that concludes my remarks.

Thank you very much Doug. Dan, we're ready to take questions.

Ladies and gentlemen, we will now be conducting a question-and-answer session (OPERATOR INSTRUCTIONS). Kevin Sarsany of Langenberg & Company.

Good morning. Could you possibly break out the core auto and the AST? In your numbers I think you combined both of them?

Kevin, we typically do not provide specific detail for the business segments.

Okay. All right. To the gross profit line, it was up higher than I expected, good performance, but could you disaggregate that a little bit from the sequential increase in volume versus the efficiencies you're getting from your lean manufacturing? Is that at all possible? I guess where I'm going is, obviously next quarter you have sequentially down revenue, so if it is all because of the volume are we going to see gross margins decline dramatically?

Kevin, we haven't really looked at trying to break that out. Obviously we do know we get some benefit from the increased sales, but we do also know that we are seeing some good results, as Don mentioned, from some of the metrics, in his comments, that we are becoming just more efficient manufacturers. So that might be something that we could look at a little bit further and maybe get back to you off-line, but I guess the best sense is that it's probably a little bit of both.

A little bit of both. Could you also comment, and I will turn it over and get back into queue here, a little bit about material prices and you mentioned price declines which I assume is in your auto business. Can you quantify what you are seeing in the material price arena and its effect on your gross profits and is the pricing deflation a little higher than normal?

Before I answer that, Kevin, we should point out that historically our third quarter is a weaker quarter because of the December automotive month. To the point on pricing, price pressures remain. They don't appear to be abating. I don't know that they are getting worse, but they are very much with us and I don't see that abating anytime in the future. As far as raw material, we are within our budgeted amounts for increases in raw materials, but it is something that we are watching, primarily coming from copper and from resins. It is something that we are watching. We are within our budget for the year but there is -- it is a concern but there is nothing that would cause us to modify anything probably for this fiscal year.

Could you put a number on the year-over-year increase of material prices and what percentage of COGS it is?

Not readily. That is something we can provide you. It is wrapped up in our purchase price of variance. You have got improvement there but it is offset by material increases. That is something we can provide.

That would be great.

And we probably can provide it primarily from auto. I don't know that we can get into some of the smaller divisions. But that would be the main area.

I would appreciate it. Thank you.

Laura Thurow of Robert W. Baird.

Good morning. Just a couple of questions for you. First, on your third quarter guidance, a housekeeping question. Does that include the schedules that we just saw yesterday from Ford and GM, was down 9 percent. Is that built into your third quarter guidance?

Yes, it is.

Okay. Another question on the guidance. If I just use the midpoints, your revenue would then be down 5 percent year-by-year but your EPS up 2 cents. With all the increases in SG&A that you're seeing from Sarbanes-Oxley and the restricted stock amortization, what is the offset there? Is that really the improvement in cost of goods sold from you're lean manufacturing? Are there other pieces there?

Laura, I think part of that, and I would have to look. I don't have last year's third quarter detail, but I don't know what tooling sales were last year. So part of that difference in sales, if it is related to tooling sales, that is basically just breakeven business. So that may be part of the difference that you're seeing.

Okay.

And we are getting some help from our smaller divisions, where a year ago they were a drag on earnings.

Right. Great. Next, could you give us an update on the new business? Really looking to see if you could quantify the amount of net new business coming online in each of the next 3 years, just to update that number.

I don't know that I can do that justice without the chart I showed at your conference. I don't know that I can answer that on the call without some graphics.

I guess just directionally, kind of the number we were looking at for your fiscal year was in the 36 million range in '05, and again this is assuming flat pricing, flat build. Directionally, I would imagine that goes up a bit. Is that fair, in '06 or '07?

Yes.

We have said that we would project a growth curve for next year, but again I think that is difficult for us to quantify on a call.

Okay. With the charges that you had in the quarter from Singapore and from the relocation of the automotive tooling, obviously the Singapore was in your expectations. I imagine that tooling relocation was not. Could you quantify that? Of that 2 cents, was it half-and-half from each?

Yes. Obviously the molder that went insolvent did not anticipate that. In the quarter we're looking at about -- that is about a penny itself. Then for Singapore, we did anticipate that we would have some transfer costs, but we did not expect -- there was about a half of $1 million in equipment that we wrote-off because we determined we could not transfer to China and so we wrote that down as impaired.

Okay. On the tooling supplier, now that the tooling itself is actually relocated, does that inhibit you going forward in terms of getting some of that tooling?

No. That is behind us. I think our team did a great job of moving over 80 tools in about a week and a half with not shutting airlines down, and more importantly, not shutting every automaker down. That is behind us.

Laura, I think as I said it was a molding supplier. They use the tools that are provided by the OEMs and then produce the (multiple speakers).

Well provided by us, owned by the OEMs.

Right. Okay. Thanks. 1 last question and then I will circle back and get back into queue. Just kind of looking at -- with your new business growing, particularly AST and the European automotive stuff, I know you're looking at about 20 million in CapEx this year. Next year, even if you cannot quantify it directionally, does that continue to go up? Does that stay at these current levels? What are your expectations for that?

I think we expect CapEx to go up, not significantly, but I think what we're seeing is there is probably more tooling that Methode will step up to win products, to win projects. And we used to be at roughly a $16 million run rate with maintenance capital. So I think that number is just moving up as we go-forward with little upward pressure, based on OEMs trying to push a little bit more of that to the suppliers.

I think as we push our divisions to present us with more cost savings opportunities and new product opportunities, we have to back that up with supporting them with capital and we have seen, such as the RJ45, we have seen that be successful for us. So we continue to reinvest in our operations in new products.

Great, thank you.

Kevin Sarsany and Langenberg & Company.

Just real quick, you mentioned in your comments about Scotland being a drag to earnings, and in 2006 being profitable, and also you talked about Shanghai. It sounds like you are about 60 percent there with the equipment and that is up and running.

Could you kind of go through the steps that seem to be leading to where Scotland and Shanghai are contributing to the operating margin and how you are going to proceed with your -- I don't know exactly how you would call it, but moving your lean manufacturing flexible to the rest of your empire here? If you could kind of run through that and future objectives. It sounds like Scotland you are expecting to be profitable in 2006 and I would assume somewhere around that time frame, Shanghai?

Let's start with Scotland. The plant in Scotland -- to launch automotive products successfully you need a certain critical mass, much more than I think you do in other product areas. So they needed to add to their engineering, add to manufacturing engineering, quality engineering and get their infrastructure in place, probably 2 years before they saw an increase in their sales. A couple of years ago we announced that we had booked a fair amount of business in Europe. So as they went through that and through the launches, and really starting a new plant is not without its problems, they were in the red. As their shipments increased, you're covering that overhead that you added and that ultimately turns to a profit here, again a slight profit. In the fourth quarter of next year, again assuming, as Laura said, flat build schedules and no issues, and they will increase their revenues and we will see the throw to the bottom-line.

Does that include any of the efficiencies that you're trying to export to that plant?

What we're doing, our domestic auto plants have done very well in their lean activities and we're really using them as guidance counselors, and so on. And in fact in about a week here, our VP of North American Automotive will be presenting lean manufacturing to our connector group here in Rolling Meadows and they will actually go out to the floor and do a (indiscernible) event. We're taking that expertise and exporting that, if you will, to our other divisions. Scotland will do something similar, although they are probably a little further along in lean than our connector group is. Also our multigroup on their own has done a good job there. We will essentially use our internal resources to migrate our manufacturing systems to the other facilities.

As far as Singapore -- excuse me, Shanghai. We moved our Singapore facility. There was a certain amount of business there. We did some product line pruning when we moved it. We also won some General Motors switch bank business that 1 switch has launched. It has not -- it's probably another year or 2 before it reaches full ramp. And then we've got I think it's a GMP (ph) 900 switch that will launch in about a year. So between what we transferred and the GM business, we will get critical mass in that facility, plus having a base of operations in China will allow us to gain additional business. And so again you need a certain infrastructure while you are ramping you're burning income, but once you get to a certain critical mass, you will throw income to the bottom-line.

Is most of the business in Shanghai related to General Motors?

No, the majority right now is related to Interconnect. I don't know what this year's shipments for GM would be, but it would be --.

But you're up and running for GM?

Correct. I don't know if we are P-papped (ph) yet or not, but we are certainly in preproduction.

Okay, thank you.

(OPERATOR INSTRUCTIONS). Laura Thurow of Robert W. Baird.

I think actually part of my question has been answered. I was just looking for kind of an update on lean manufacturing and how that is going, and it sounds like it is going quite well. But any kind of additional color on where we are in the game and your domestic plants, would be great.

Domestically, our automotive plant in Carthage and in Golden, Illinois are probably 70 percent through their lean journey. They have also started lean in Monterrey, Mexico and Reynosa. And I don't know that I want to try to put a percentage of that. We have seen benefits of it, particularly in AST where we have seen lower labor required because of their lean initiatives. So they are probably the -- those 4 plants are the most advanced and have gotten very high marks from customers, and particularly the Japanese, as we pursue the transnationals. And I think I indicated they are running 12 PPM which is clearly world class. So they have done quite well. Malta also, I would say, is probably up to the same status as automotive here in the U.S. Scotland is probably a year behind them. And then the balance of the Methode plants, I hope I'm not leaving anybody out here, but I think the balance are really just beginning their journey. Next year will be the first full year that they will actually have budget targets they will have to achieve from the lean initiatives this year is more of a training, and getting them to be believers in the system.

Great, thank you.

We show no further questions in the queue at this time. I would like to turn the floor back over to our speakers for any closing comments.

Thank you, and we thank everyone for joining us and wish everyone a safe and pleasant holiday season. Have a pleasant day.

This concludes today's conference. Thank you for your participation.