Methode Electronics Inc (MEI) 2008 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Methode Electronics second-quarter fiscal 2008 conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS).

This press release 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 press release involve a number of risks and uncertainties. The factors that could cause actual results to differ materially from our expectations are detailed in Methode's filings with the Securities and Exchange Commission, such as our annual and quarterly reports. Such factors may include without limitation the following -- dependence on the automotive industry; dependence on a small number of large customers within the automotive industry; intense pricing pressures in the automotive industry; customary risks related to conducting global operations; increases in raw materials prices; the successful integration of acquired businesses; dependence on the appliance, computer and communications industries; the marketability of our intellectual property; and the seasonal and cyclical nature of some of our businesses.

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Don Duda, President and Chief Executive Officer for Methode Electronics. Thank you, Mr. Duda. You may begin.

Thank you. Good morning, everyone. Thank you for joining us today for our fiscal 2008 second-quarter financial results conference call. With me on the call is Doug Koman, our Chief Financial Officer; Ron Tsoumas, Methode's Controller; and Joey Iske, Director of Investor Relations. Both Doug and I have comments, and afterwards we will be pleased to take your questions.

Methode completed the second quarter of our 2008 fiscal year with net sales of $133.2 million and net income of $8.8 million or $0.24 per share, compared to sales of $108.5 million and earnings per share of $0.13 in the second quarter of fiscal 2007. This was an increase of almost 25%, due to strong sales in all three of our markets served -- North America, Europe and Asia.

In Asia, automotive production volume remained strong. Our team in Shanghai has been very busy with tooling and production line development for several new programs launching in the coming year. In fact, a steering angle sensor production line was installed for General Motors with successful validation testing. This SAS line is the first Methode production line tooled completely in China. This is a big step for the Group, and this added capability should aid in further program wins in the region.

We continue to see solid demand in Europe for our automotive products that resulted in several programs being carried over to additional model years. In addition, new program launches included a host of products for Ford of Europe, Fiat, Aston Martin, Land Rover and Volvo. Most of these programs will run through at least 2012.

We are now realizing the benefit of last year's successful transition of automotive manufacturing from our Scotland facility into our Malta operation. This move provided solid improvements to profits during the quarter.

In North America, the automotive team worked closely with engineers in our Interconnect segment and began the launch of an insert-molded lead frame for a transmission controller that will be used across several platforms. In addition, we received price increases on certain legacy products we had previously decided to exit. However, at the request of our customer, we are continuing with the manufacturing as transition plans are being implemented. It is estimated this business will continue through our 2008 fiscal year.

Excluding the price changes, sales and production levels were still strong in the second quarter. Further, prior cost reduction efforts undertaken in anticipation of lower automotive sales during this model year have resulted in greater efficiencies, producing higher profits.

During the second quarter, new automotive business was booked in all of our operating regions. Europe will increase its content with Fiat and Ford of Europe beginning in 2010, and when the products are in full production should produce annual sales of approximately $6 million. These are multi-year programs running beyond 2015.

In China, Cherry Automotive will use Methode's column electronic assembly or CEA on five platforms beginning in 2010. When these programs are in full production by 2011, they should provide roughly $12 million in sales annually for an initial three-year period.

In addition, General Motors will deploy our CEA on their GSV platform, or global small vehicle, which is an exciting new program for Methode and will be built in our China facility. The GSV is scheduled to be sold in multiple markets such as Asia, Europe, North and South America, the Middle East, Thailand and India. We anticipate this program to provide significant production volume. The program will launch in 2011, producing about $18 million in first-year sales, then ramping to an estimated $30 million a year for the next several years.

Methode Shanghai Automotive Technology or MSAT has been developing a solid book of business over the past couple years. To put this into perspective, including the new Cherry and GM business, MSAT will be producing nearly $90 million in annual sales by the year 2012.

Globally, the automotive segment's promotion of MDI's Magna-Lastic sensing technology and TouchSensor's solid-state switching technologies continue to gain momentum. Several OEMs and Tier 1 companies have shown significant interest, with several customers requesting and being provided prototypes.

Sales in the Interconnect segment increased almost $12 million in the second quarter of this 2008 fiscal year. The main driver of this increase was the addition of sales by TouchSensor Technologies, which we acquired in March of this year. During the quarter, TouchSensor was focused on launches for two major customers, which included user interface panels for dishwasher, cooking and refrigeration platforms. Additional refrigeration and dishwasher platforms are scheduled for launch this month and also in January. Other launches during the quarter included vending and fitness machine user interface panels and liquid level sensors, all using TouchSensor's patented field-effect switching technology.

Elsewhere in Interconnect, we are on schedule to have prototypes ready in the first quarter of calendar year 2008 for evaluating our 10-gigabit copper transceivers. These will be the first such products in the world, and will provide us with an excellent global opportunity similar to the one we have enjoyed by being first to market with the 1-gigabit version.

Our Power Distribution segment experienced a decrease in sales for the quarter of just over 3%. This includes the acquisition of Value Engineered Products or VEP, which we acquired in August of this year. Bus bar sales were negatively impacted in the US, due to a customer getting a second source for product which previously had been supplied solely by Methode. However, new order intake from a variety of customers has been brisk. In addition, we continue to receive prototype orders on several projects that will further our expansion into military.

In Europe, we have signed a supply agreement with one of Europe's largest manufacturers of wind power generators. Also in this segment, power cables had lower-than-expected sales due to an order slowdown by a computer industry OEM and a design change by [a military] OEM. However, we believe the military business will be increased through this recent design change, but it has pushed out sales in the short term.

I wanted to make couple of additional comments before I conclude and turn the call over to Doug for his financial review. In early November, we held our second investor day. I would like to thank each participant who attended this event. Our teams presented several new prototype lines using new TouchSensor and MDI technologies. In addition, our division management did a fine job of presenting their business units, discussing their product lines and market opportunities.

Also, on November 27th, Fox News of Chicago aired an investigative report regarding lead paint found in pet toys manufactured in China. Our Trace Laboratories subsidiary was highlighted as the lab that concluded the tests on behalf of the television station. We were pleased to have been chosen as a lab qualified for lead testing, and seek to heighten the awareness of these capabilities, as additional testing is sure to be required for certain products manufactured in China.

Moving the guidance, given the strength in Methode's worldwide automotive markets, the Company is increasing its fiscal 2008 full-year guidance for sales between $500 million and $515 million, and for earnings per share between $0.80 and $0.87.

At this time, I will turn the call over to Doug for his financial commentary.

Thank you, Don. Good morning, everyone. Let me start by reviewing the sales and gross margin results for our reporting segments. The Automotive segment had second-quarter net sales of $89.8 million, compared to $76.1 million last year. That's an 18% increase in automotive sales. For the six-month period, the Automotive segment had net sales of $172.7 million, compared to $150.2 million last year, a 15% increase.

The increase in sales was from organic growth at our European and Asian operations and North American Automotive sales were stronger than we had expected. Additionally, as Don has mentioned earlier, Automotive sales were also impacted by price increases of $3.7 million and $5 million in the second-quarter and six-month period, respectively. The weaker US dollar positively affected sales from our foreign operations by $1.7 million or 1.9% in the second quarter, and by $3.1 million or 1.8% in the six-month period.

In the second quarter, gross margins for the Automotive segment were $18.5 million or 20.6% of sales, compared to $10.9 million or 14.3% of sales last year. For the six-month period, gross margins for the automotive segment were $34.9 million or 20.2%, compared to $22.3 million or 14.8% of sales. This improvement is the result of shifting US and UK production to the lower-cost regions in Asia, Europe and Mexico. Additionally, North American sales were stronger than expected, and were impacted by the price increase mentioned earlier.

The Interconnect segment had net sales of $30.3 million in the second quarter. This is up 64.7% from $18.4 million last year. For the six-month period, the Interconnect segment had net sales of $61.7 million, compared to $36.2 million last year. That's a 70.4% increase in net sales. The increase is substantially due to sales from TouchSensor, which was acquired on February 28th of this year. The remaining businesses in this segment had slightly higher sales overall in both the quarter and six-month period. Currency translation increased foreign sales by about $200,000 and $400,000 in the second quarter and six-month periods.

Gross margins for the Interconnect segment were $6.7 million or 22.1% of sales, compared to $5.1 million or 27.7% last year. For the six-month period, gross margins were $14.4 million or 23.3%, compared to $10.6 million or 29.3% of sales last year. The decrease in percentage of sales is primarily the result of the TouchSensor acquisition, which currently has higher cost of products sold than the other businesses in the segment. We also experienced higher costs related to the rollout of our PC card adapter products.

Power Distribution segment sales were down in the quarter, as Don mentioned earlier, with sales of $11.6 million this year, compared to $12 million last year. For the six-month period, the sales this year were $20.7 million, down from $22 million last year. Again, the decrease primarily relates to certain projects for a customer for whom we are no longer the sole supplier. This was partially offset by sales from the VEP acquisition, which closed on August 31st.

Gross margins decreased to $3.1 million from $3.5 million as a percentage of sales; that's a 26.7% compared to 29.2% last year. The reduction is primarily due to higher material costs and some price erosion at our North American operation, again primarily as it was impacted by no longer being the sole supplier on certain product. This was partially offset by margin improvement at our Shanghai, China operation.

For the six-month period, gross margins decreased to $5.7 million or 27.5% from $5.9 million or 26.8% last year. The improvement in percentage for the six-month period is because of cost savings and Lean activities in Shanghai, China, which exceeded the higher material cost and price erosion in North America.

The Other segment had second-quarter sales of $1.6 million. This is down from $2 million last year. For the six-month period, this segment had $3.2 million in sales, compared to $3.7 million last year.

Gross margins decreased to about $0 in the second quarter, compared to about $0.5 million last year. For the six-month period, gross margins dropped to about $100,000 from $900,000 last year. This is primarily the result of continued investment initiatives in our torque sensing business.

If you turn to the financial highlights in our earnings release, I'll walk you down the rest of the consolidated income statement. Selling and administrative expense in the second quarter was $16.1 million, up from $13.3 million last year. As a percentage of sales, however, selling and administrative improved slightly to 12.1%, compared to 12.3% in last year's quarter. For the six-month period, selling and administrative was $32.1 million, compared to $27 million last year. As a percentage of net sales, however, sales and administrative improved to 12.4%, compared to 12.7% in last year's six-month period.

The increase in spending is primarily due to TouchSensor and VEP acquisitions. The remainder of the increase in actual spending is primarily related to higher stock award amortization and professional fees.

Interest income net was about $600,000 for the second quarter, compared to $900,000 in last year's quarter, and for the six-month period, interest income was about $1 million compared to $1.7 million last year. The reduction is primarily the result of lower average cash balances compared to last year; that's due to the recent acquisitions. Then also, this year, we are more heavily invested in tax-free municipals.

Other net went to an expense of $900,000 in the second quarter, compared to income of $400,000 last year. For the six months, other net went to an expense of $1.2 million from income of $300,000 last year. The increase in expense is substantially due to the impact of the weaker dollar on the activities of some of our foreign operations.

The effective tax rate in the quarter was 23%, compared to 34.3% last year. The tax rate for the six-month period was 24.1%, compared to 35.8% last year. Last year's tax rate was higher, primarily due to the establishment of valuation allowances for potentially nondeductible stock-based compensation. Both years reflect utilization of investment tax credits and the effect of lower tax rates at the Company's foreign operations.

If we can move to the balance sheet, cash is up to $82.8 million, compared to $60.1 million at year end. I'll explain this in more detail when I get to the cash flow statement. Accounts receivable balance is $78.4 million, down slightly from $79.2 million at the end of last fiscal year. Not much of a change here, since both of these accounts receivable balances are following quarters with comparable sales.

Inventory is $56.7 million, up from $54.5 million at year end. The increase is primarily due to the additional inventory at TouchSensor to support new launches occurring later this fiscal year and inventory from the VEP acquisition.

Other current assets are $15.3 million, down from $15.7 million last year. This is primarily due to amortization of prepaid expenses.

Property, plant and equipment is at $89.2 million. This is up from $86.9 million last year. The increase primarily reflects our investment in paint and laser etch capabilities and additional printed circuit board assembly lines.

Goodwill is at $56.6 million, up from $51.5 million at the year end. Primarily, this is related to the VEP acquisition. We also had a purchase price adjustment payment related to the TouchSensor acquisition and and earnout payment on the Cableco acquisition. Even though we acquired some intangibles with the VEP acquisition, intangible assets or slightly down at $42.7 million from $43.7 million at year end, due to normal amortization.

Other assets at $22.1 million are up slightly from $20.2 million, primarily due to balance sheet reclassification of tax accounts upon the adoption of FIN 48 at the beginning of the fiscal year. We also had adjustments between current and noncurrent deferred tax accounts.

There's no material change in accounts payable. We are currently at $41.3 million versus $41 million at year end. Other current liabilities at $37.1 million are up from $31.4 million at year end, primarily due to the customer prepayment for the price increases on product being produced over the remainder of this fiscal year.

Other noncurrent liabilities are $20.7 million. They are up from $15.1 million at year end. Again, this is primarily due to the balance sheet reclassification of accounts, due to the adoption of FIN 48 at the beginning of the fiscal year.

On the cash flow statement, year-over-year cash provided by operating activities increased $19.3 million. This is primarily due to the increase in net income, the customer prepayment and other working capital account changes.

The $11.4 million increase in cash used in investing activities is primarily due to the VEP acquisition, higher capital spending this year compared to last year. We also made a dividend payment on the joint venture that we operate.

The decrease in cash used in financing activities is primarily due to fewer stock options being exercised. Last year, we had repurchased $1.9 million of common stock, and we have made no repurchases this year.

Don, that concludes my comments.

Thanks, Doug. We are ready to take questions.

(OPERATOR INSTRUCTIONS). David Leiker, Robert W. Baird.

I want to dig through this, your comments on Chrysler and the price increase and things like that. I guess you got some of this in the previous quarter. Is that correct?

We mentioned in the last Q that we did have a prepayment, yes, in the first quarter.

Is this price increase here, $3.7 million -- is that a sustainable pace going forward?

That's not what we said in the press release.

No, that's not what we said.

What we said is we decided to exit low-margin or unprofitable products, and at the request of the customer, we maintained production for a certain period of time on exchange for price increases. So no, that's not -- I mean, we'll stand by what we say in the Q and the press release.

Let me rephrase that. This price increase you got -- that's going to show up in subsequent quarters, or is that just kind of a one-time payment?

The price increase will -- we're producing this product through the end of the fiscal year. (multiple speakers). That's all we have right now.

Right, you're going to produce it for two more quarters where we're going to have a $3.5 million, $4 million positive price impact in each of the next two quarters?

Approximately, yes.

Is that fair? Okay. I'm just curious -- on the discussion when we were talking about the margins down at your analyst day, that this wasn't part of the discussion of why margins in the automotive business are higher and sustainable in the near future.

Well, one, during the investor and analyst say, we were in a quiet period. So we wouldn't be discussing that.

But if you already realized some of it in the previous quarter? I'm just trying to follow through on that.

Let me say this. First of all, we continue to have ongoing discussions with an automaker. I'm not going to say which automaker it is. Those discussions are -- as you might imagine, when you talk about price increases and transferring products, those are very sensitive.

So I realize you'd like additional information, but I think what we provided in the Q is about all that I'm comfortable in commenting on. I have to respect the confidentiality relations that we have with our customers. To provide more color on that --

No, I understand that. I'm just looking at it in the context that it was a positive to margins in the first quarter, and we have a discussion about how sustainable the profitability of the first quarter is, and part of the discussion is, hey, we got a price increase and it's going to go through the end of the life of this product. I don't remember that being part of the discussion of why margins in the auto business are sustainable. I mean, it's a good thing, but it's -- unless I missed something in the day that we were there.

I guess the way to answer that is we were in discussions with the customer. The impact in the first quarter, if you do the math, you can look at the six-month and the second-quarter numbers, was about $1.2 million, $1.3 million. It wasn't that significant in the first quarter, and we were aware of that. That was taken into consideration when we maintained guidance at the end of the first quarter. So I guess I don't know what more we can say about that.

So what you're doing right now is some business that was going to roll off sooner, you're going to continue to produce until the end of April. Is that correct?

Yes.

And you're in negotiations on whether that's going to continue going forward or not? Or is that going to go away in 2009, as we've been talking for the last two years?

Again, I'm not --

Let me ask it this way. Are you trying to keep that business if you get the right price?

I'm going to stick to my previous comment. Those are sensitive discussions, and as those conclude one way or the other -- and chances are it's a bit of a mixed bag -- then we will discuss it.

But it's a very sensitive area. I understand your wanting to understand it a little bit further, but I think we've provided as much information as is appropriate at this point. I'd be speculating if I go any further, and I don't want to do that.

Very well. Let me try this one last time here. At your analyst day, we talked about your legacy automotive business and that you're exiting them. It now sounds like you are not necessarily going to exit them.

I would not draw that conclusion.

If we take the price increase out of the numbers, look at gross margins and operating margins, it looks like things would have been a little bit weaker than what we would have expected. Is there anything going on there that we should be talking about? It looks like you had contribution margin ex- the price increases that's below what you would have done in the past.

Well, I don't know whose expectations you are talking --

Let's look at the contribution margin. Your contribution margin ex- the price increases is a little bit below what you would have done in the past.

I don't know if that's -- well, we haven't dissected our results that closely to look at the with and without. So I don't know if I can discuss this with you at this time.

In the last two quarters, you generated 30% contribution margin. If you pull the price increases out, it's a 20% contribution margin. I was trying to understand what the difference is. It sounds like you didn't think through that.

That's compared to what?

The previous two quarters.

We've also discussed what's going on in the Power segment, so I'm not sure that this -- this wasn't unexpected.

A couple last things. Your depreciation number is running at a higher pace than what it had been. Is that a pace that we should expect it to run here going forward?

Probably with the acquisitions, yes, it will be higher.

So for your full year, you think depreciation is $30 million?

For the full year, no, not $30 million, because in the quarter we're running at -- are you talking about depreciation and amortization?

Depreciation and amortization.

Yes, that will be closer, probably somewhere in the high 20's.

And capital spending? Where would you expect that to be?

We're probably still comfortable with about $20 million for the full year.

Then one last thing -- your tax rate for the full year?

We're using something in the middle, between 25% and 30%, so 26%, 27% is what we're factoring.

(OPERATOR INSTRUCTIONS). Gentlemen, it appears we have no further questions. I'd like to turn the floor back over to management for any closing comments.

Thank you. I think we'll conclude the call by thanking each of our divisions for an excellent quarter and their contributions to Methode, and we wish everyone a very good day. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.