Methode Electronics Inc (MEI) 2008 Q3 法說會逐字稿

Greetings ladies and gentlemen, and welcome to the Methode Electronics Incorporated third quarter 2008 earnings 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.

This conference call contains certain forward-looking statements which reflect management's expectations regarding future events and operating performance, and speak only as of the date hereof. These forward-looking statements are objects to the Safe Harbor protection provided under the Securities laws. Methode undertakes no duty to update any forward-looking statements to conform the statement to actual results, or changes in Methode's expectations on a quarterly basis, or otherwise.

The forward-looking statements expressed in this conference call involve a number of risks and uncertainties. The factors that could cause actual results to differ materially from our expectations are detailed in Methode's filings with the Securities and Exchange Commission, such as our annual and quarterly reports.

Such factors 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, customer risk related to conducting global operations, increases in raw material prices, successful integration of required businesses, dependence on appliance, computer, and communication industries, the marketability of our intellectual properties, and the seasonal and cyclical nature of some of our businesses.

It is now my pleasure to introduce your host, Mr. Donald Duda, President and Chief Executive Officer for Methode Electronics Incorporated. Thank you Mr. Duda. You may begin.

Thank you, Anthony. Good morning, everyone. Thank you for joining us today for our fiscal 2008 third 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 third quarter of our 2008 fiscal year, with net sales of $138.5 million, and net income of $9.8 million, or $0.26 cents per share, compared to sales of $105.4 million, and earnings per share of $0.13 in the third quarter of fiscal 2007. This represents a sales increase of 31%, due to strong sales in all three of our markets served, North America, Europe and Asia, as well as a net income increase of 109%.

In Asia, automotive production volume remains strong. We continue to work on the General Motors column electronics assembly and steering angle sensor programs. At this time, all program designs for Cherry Automotive have advanced to the production tooling phase, and we expect launches to commence in model year 2010. Due to the growth and expansion of our Asian automotive business, Methode has signed a lease on an additional manufacturing building, we anticipate moving into the facility this spring.

We continue to see solid demand in Europe for our automotive products, and to realize the benefits of last year's successful transition of automotive manufacturing, from our Scotland facility into our Malta operations. In the third quarter our Malta operations increased its Lean manufacturing efforts, with redesigns of certain assembly lines, as well as increased efficiencies on the new paint and laser etch manufacturing system. Both contributing to our reduction scrap costs by 13% over the previous quarter.

In addition, automotive sales were positively impacted in the third quarter, due to one-time price increases of $5.4 million, on previously marginally profitable and unprofitable products, which we had decided to exit at the expiration of our manufacturing commitment. But at the request of the customer, have agreed to continue production. Presently Methode expects to complete the exit of these products during the second quarter of our fiscal year 2009. New automotive business was booked in all of our operating regions during the first quarter. Europe will increase it's content with Volkswagen, Land Rover, and Ford of Europe, beginning in model year 2010.

The China automotive business was awarded additional switch business with Cherry Automotive, again launching in 2010. Also during the third quarter in North America, Methode was awarded a contract for a new infotainment console, which will incorporate our TouchSensor technology. This product will debut on three platforms scheduled to launch in model year 2011, and continues our evolution into a provider of complete product solutions to our customer base.

New automotive business awards during the quarter when in full production in model year 2011, will provide nearly $12 million in annual sales. Additionally, Methode received a General Motors Supplier Recognition Award, for our excellent performance in the highly engineered lead frame assembly for the a major GM transmission program.

Lastly in auto, the Automotive Group, in conjunction with the Methode's MDI business unit, will demonstrate MDI's Magna-Lastic sensing technology during the Society of Automotive Engineering Conference on April 15th. We will be displaying several different potential applications utilizing the MDI technology, such as transmission torque sensing for engine management, brake force sensing for electric brakes, passenger weight sensing for safety systems, and steering torque measurement for stability control systems. While we are on the prototype stage with certain automotive OEMs, this show will be Methode's first significant exhibit of the MDI technology for the automotive industry.

Turning to our Interconnect segment. Sales increased in the third quarter, mainly driven by sales from TouchSensor Technologies which we acquired in March 2007. We are now shipping product on several new platforms for a large international OEM. The products include interface panels for ranges, wall ovens, cook tops, refrigerators, and dishwashers. In addition, we launched a sensor application on a portable medical device, Methode's first medical win and launch utilizing the TouchSensor technology. TouchSensor has begun it's entry into Europe by recruiting a business development manager to promote the technology, and extend our customer base in that region.

Elsewhere in Interconnect our ExpressCard cases continue to book new business, with five new awards during the quarter. These originate in both Asia and North America, and include customers such as Huawei, Sierra Wireless, SMART Modular, and Sony Ericsson. Our Power Distribution segment continues it's organic growth, along with the expansion of it's power distribution solutions through an acquisition.

A new customer to Methode has chosen our patented power rail system, for inclusion in a new server design. Power rail is also gaining headway in high current connector application, having garnered approvals by several industrial leading OEMs. Volume remains strong on a military future combat system for an integrate high-voltage power cable system manufactured by Methode's Cableco business unit.

The acquisition of Tribotek announced early this week, expands our high-power connector designs. Tribotek designs and manufactures high current power connectors and power distribution systems, for products, such as rectifiers and inverters, power supplies, servers, robotics, and automated test equipment, in addition to various military applications.

Tribotek's patented technology allows the power connectors to yield a lower insertion loss, lower voltage drop at the connection point, and can reliably handle a greater number of plug and unplug cycles, than conventional power interconnect products. The acquisition of this robust power interconnect product line is one more example of Methode's commitment to grow our Power Distribution segment, and offer more complete solutions to our valued customers.

Moving on to guidance, due to the customer delay in transferring products, which Methode expected to transfer by the end of the third quarter, the Company is increasing fiscal year 2008 guidance for sales to between $525 million and $540 million, excluding the impact of any prolonged work stoppages, such as at American Axle, which could impact Methode's customers. Earnings per share guidance also increased to between $0.93 and $0.98, and does not reflect any charge for restructuring, but may be recorded in Methode's fourth quarter of fiscal 2008.

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

Thanks. Good morning, everyone. Let me give you some of the segment detail behind the consolidated results.

The automotive segment had third quarter net sales of $88.6 million, compared to $72.2 million last year. That is a 22.7% increase in sales. For the nine month period, the segment had sales of $261.3 million, compared to $222.4 million last year, an increase of 17.5%. The increase in sales was from organic growth at both our European and Asian operations, and as Don mentioned earlier, automotive sales were also impacted by the one-time price increases of $5.4 million in the third quarter, and $10.3 million in the nine-month period.

The weaker U.S. dollar positively impacted sales from our foreign operations by $2.6 million, or 2.9% of sales in the third quarter, and for the nine month period, we saw benefit of $5.7 million, or about 2.2% of sales. In the third quarter, gross margins for the automotive segment were $18.7 million, compared to $9.8 million last year. As a percentage of sales, margins were 21.1%, compared to 13.6% last year.

For the nine month period, gross margins for the automotive segment were $53.2 million, compared to $32.1 million last year. As a percentage of sales, gross margins were 20.4%, compared to 14.4% last year. The improvement is primarily the result of the one-time price increases mentioned earlier. Without the price increases, gross margins would be down in this segment, primarily due to a worsening North American market, offset by improved sales in both Europe and Asia, and also from the efficiencies gained from the integration of the Scotland operation last year into the Malta facility.

Moving to the Interconnect segment, we had sales of $35.6 million in the third quarter, which is up 79.8% from $19.8 million last year. For the nine-month period, the Interconnect segment had sales of $97.2 million, compared to $56 million last year. That is a 73.6% increase in net sales. The increase is substantially due to sales from TouchSensor, which was acquired during last year's fourth quarter. The remaining businesses in this segment had slightly higher sales overall in both the quarter and the nine months.

Currency translation increased foreign sales by about $0.05 million in the third quarter, and about $800,000 in the nine month period. Gross margins in the Interconnect segment were $7.8 million, or 21.9% of sales, compared to $6.4 million, or 32.3% last year. For the nine month period, gross margins for the Interconnect segment were $22.1 million, or 22.7% of sales, compared to $17 million last year, or 30.4% of sales. The decrease in gross margin as a percentage of sales is primarily the result of the TouchSensor acquisition, which has higher cost of products sold than the other businesses in this segment.

We also experienced higher costs related to the rollout of our PC card adapter products, and our data installation business was impacted by softer year-over-year sales. Power distribution segment sales were up in the quarter with $12.5 million this year, compared to $11.4 million last year. For the nine month period, sales were $33.2 million, just about flat with last year's $33.4 million. The quarter and nine months benefited from sales from the VEP acquisition that closed on August 31st, 2007. This was partially offset by a reduction in sales on certain projects for a customer for whom we are no longer the sole supplier.

Gross margins in the Power Distribution segment increased to $3.6 million in the quarter, from $3.5 million last year. As a percentage of sales, however, margins decreased to 28.8% from 30.7% last year. The percentage decrease is primarily due to higher material costs, and some price erosion in our North American operation. This was offset by a cost savings and Lean activities at our Shanghai, China, operation. For the nine month period, gross margins were $9.3 million, or 28% of sales, just about flat compared to the $9.4 million, or 28.1% of sales last year.

The Other segment had third quarter sales of $1.8 million, down from $2 million last year, for the nine month period sales were at $5 million this nine month period compared to $5.7 million last year. Gross margins were about at a breakeven for the current third quarter period, compared to a $400,000 benefit last year. For the nine months, the gross margins also dropped to breakeven for the nine months again, compared to about $1.3 million last year. The reduction in gross margins in both the quarter and the nine month period is primarily the result of increased initiatives in our torque sensing business.

We turn to the financial highlights, we can go down the rest of the consolidated income statement. Selling and Administrative expense in the third quarter was $17.8 million, up from $12.9 million last year. As a percentage of sales, selling and administrative increased to 12.9% compared to 12.2% last year. For the nine month period, selling and administrative was $49.8 million, compared to $39.9 million last year.

As a percentage of net sales, however, selling and administrative was 12.6%, which is the same as last year's nine month period. The increase in spending is primarily due to the TouchSensor and VEP acquisitions. The remainer of the increase is primarily due to the additional global support staff, increased long-term incentive compensation. This was due to improved performance, and also a higher stock price, and higher professional fees.

Interest income net was $700,000 in the third quarter compared to 1 million in last year's quarter. For the nine months, interest income was $1.7 million, compared to $2.8 million last year. The reduction is primarily due to lower nominal interest rates this year versus last year, lower average cash balances this year compared to last year. This is due to again, the recent acquisitions. And also that the average yield on our investments is lower this year compared to last year since we were invested in fax-free municipals this year, compared to last year when we had no investments in that sector.

Other net was an expense of $900,000 in the third quarter, compared to an expense of $300,000 last year. For the nine months Other net was an expense of 2.1 million, compared to zero last year. The increase in expense is substantially due to the impact of the weaker dollar, and the activities on some of our foreign operations, and a loss recorded in the quarter for a reduction in the net asset value on a short-term investment.

The effective tax rate in the quarter was 13.8%, compared to 29.9% last year. The tax rate for the nine month period was 20.7%, compared to 33.9% last year. The effective tax rate in the current year benefited from the expiration of the statute of limitations during the third quarter, on some tax positions that were previously reserved, and a favorable tax return to tax provision adjustment in the third quarter, when we filed our fiscal 2007 tax returns. Last year's tax rate was high primarily due to the establishment of the valuation allowance for potentially non-deductible stock-based compensation. Both year's reflect utilization of investment tax credits and the effective lower tax rates at the Company's foreign operations.

Moving to the balance sheet, cash is up $90.5 million, compared to $60.1 million at year end. And we can talk to the cash flow statement a little later. The Accounts Receivable balance is $71.3 million, down from $79.2 million at the end of fiscal 2007. Receivables are down primarily due to the collection of customer tooling receivables, and benefited from a customer prepayment for one-time price increases.

Inventory is $59.5 million, that is up from $54.5 million at year end. The increase here is primarily due to increased customer-funded tooling balances, primarily related to increased automotive business in Europe. Additional inventory at TouchSensor to support new launches occurring later, actually, they have begun this current quarter, and inventory from the VEP acquisition, where we had no inventory last year.

Other current assets are $13.4 million, down from $15.7 million last year. This is primarily due to the amortization of prepaid expenses. Property Plant & Equipment is $90.6 million, this is up from $86.9 million at year end. The increase primarily reflects our investment in paint and laser etch capabilities, and additional printed circuit board assembly lines.

Goodwill is $54.2 million, up from 51.5 at year end primarily related to the VEP acquisition. We also had some purchase price adjustments on our final accounting for the TouchSensor acquisition, and we also had an earn-off payment on the Cableco acquisition. Even though we acquired some intangibles with the VEP acquisition in this year, this was offset by normal amortization expense, therefore intangible assets are unchanged from the $43.7 million at year end. Other assets are $23.1 million. These are up slightly from $20.2 million.

This is primarily due to balance sheet reclassification of tax accounts relating to the adoption of FIN 48 at the beginning of the fiscal year. And we also had adjustments between current and noncurrent deferred tax items. Accounts Payable at $38.3 million was down slightly, from the $41 million at year end, and this is because we ended the year at a large disbursement cycle in the U.S.

Other current liabilities at $31 million is just about flat compared to $31.4 million last year. The other non-current liabilities at $19.5 million are up from $15.1 million at the end of the year. Again, this is impacted primarily due to the balance sheet account reclassification, due to the adoption of FIN 48, and then it was also offset by deferred compensation payments made relating to the TouchSensor acquisition.

The cash flow statement, year-over-year of cash provided by operating activities increased $13.3 million. This is primarily due to an increase in net income, a customer prepayment, and other working capital account changes. The $14.3 million increase in cash used in investing activities is primarily due to the VEP acquisition, higher capital spending this year compared to last year, again primarily for new paint and laser etch capabilities in the printed circuit board assemblies. We also made a dividend payment on the joint venture this year. The decrease in cash used in financing activities of 4.3 million is primarily due to fewer stock options being exercised this year, and last year we repurchased 1.9 million of our common stock, this year we have made no repurchases.

Don, that concludes my remarks.

Thank you Doug. Anthony, we are ready to take questions.

Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. (OPERATOR INSTRUCTIONS) One moment as we poll for questions. Our first question comes from the line of David Leiker with Robert W Baird. Please proceed with your question.

Good morning.

Good morning, David.

Hey, the Interconnect business, I want to dig through that a little bit and try to understand a little bit more of the pluses and minuses there, a pretty good revenue number there, but the profit number down pretty meaningfully year-over-year, as well as sequentially, and try to get an idea of what your expectations are for that going forward?

Okay. We will go through the companies a little bit, although I am not going to go through each income statement of the Company.

No, just qualitative is fine.

The biggest change year-over-year that we see in Interconnect is in our PC card business where that is not as brisk as it has been. We incurred more cost launching on some products that we anticipated, and I am not saying that that market is softening, but it is just not where we had anticipated it to be.

We had some launch issues, as I said, more outside consultants, and some software issues, and we needed to deal with. We are addressing those, but I think that is probably the biggest I guess negative on that group.

And [ved] installation had a great year last year. I think with all due respect to them, I think they took their eye off the ball a little bit on sales. They had to recover a bit. We are seeing a recovery now, but they had a good year, and that is really dependent on what installs they can garner, and I think they have made changes, we have got a new general manager, and so we expect that to recover in the coming fiscal year. So I think those were the key drivers in the Interconnect segment.

And so do we think the PC card business, is this a pattern we should expect here for the next several quarters. or what is the timing of that performing better?

We are taking remedial action now, I would say.

Well, I mean, I think the software issues I don't expect those to recur. We took some inventory adjustments, which we think are sufficient to, we don't expect to see any of those. So we have a little bit of that in the quarter and the nine months for that PC card business.

Yes, I would say we would start to see the results of those actions in the first half of the coming fiscal year. I don't think we will see them immediately, but I think we will see them evolve through the first half.

Okay. And then on the pricing issue with this business that you are still doing. That amount is running higher than what it was in the second quarter, and I just want to know if that is what you were expecting it to be, or if there's something else going on there?

You are talking about the Automotive?

The automotive, Yes, the $5.4 million.

Well, the transfer was delayed.

Right.

At the end of the previous quarter, we didn't expect that. So, I mean, that is really the driver there. And as we said, that will go into our next fiscal year now.

So why was it larger than what it was in the second quarter? Was it winding down at the end of that quarter, and then started up again, or --?

Well, I just think that was volume dependent.

Okay. Can you give us any insight about what kind of number that is, as we go forward? I mean, is this $5.4 million a reasonable number, until that is gone at the second half of next year?

Boy, I don't want to, it depends on --

It depends just how quickly they do transfer the product out, and the reason it is higher in the quarter is we just as Don said, we thought it would have been transferred. So when it didn't get transferred out, those prices continue. But we expect to be out by the second quarter.

Yes, I think at this point, we feel that the customer has sufficient momentum behind it now to insure the product does transfer. There may be some slippage, but I think we may get some things out sooner too.

When will that transfer be done?

They are motivated to get it out.

What does the process of transferring that out begin?

When does it?

Yes.

I mean, it has been ongoing, but they haven't, I don't want to misspeak here.

I am just trying to get the 5.4. In Q2 of next year, it is going to be close to zero, right? Or Q3, it's going to be zero?

Yes, I think we are fairly confident that they will hit those revised targets now.

And I wonder how the $5.4 million winds down to zero over the next three quarters.

I don't know if I can tell you that, because I didn't get it right last quarter.

Well, you have something embedded in your guidance. What are you assuming for your guidance?

For the fourth quarter?

Yes. Well, for your full year.

Well, I mean --

Yes. I mean, year-to-date, it's about $10 million or so.

Any of the transfers that start, I don't think will significantly impact the quarter.

No, not in the fourth quarter.

So fourth quarter would be comparable to the third quarter?

I mean, I think that's safe --

Yes, I mean it is mix dependent.

Well, you have something in your guidance, right? You have something --

It is a range.

(laughter)

Okay. Thanks. Thank you.

Okay.

There are no questions in queue at this time. (OPERATOR INSTRUCTIONS) We have a follow-up question from the line of David Leiker with Robert W. Baird. Please proceed with your question.

Some number of questions. Your depreciation and amortization number looks like it is running a little bit higher. Where do you think that ends up being for the year?

Yes, we are probably going to be for the full year, we will probably be somewhere around, between 22 and 23.

For depreciation. What about amortization?

Amortization, again, we are looking at just amortization of intangibles. That one gets impacted by, we haven't closed or done the final accounting on VEP, for instance, so when we get the final appraisal, we will get some different numbers, I am sure between goodwill and intangibles, but I would think that we are probably maybe close to $10 million maybe for the full year.

And where do you think those numbers go for next year?

For next year on a full-year run rate, it would be probably about -- yes, it should be about the same, maybe a little bit above 10 on a full-year run rate.

And your depreciation, comparable number or a little higher?

Yes, we will probably be at a run rate that's closer to what we see in the current quarter. Yes, I would say yes. So we will probably be creeping up to, you know, $24 million.

Okay. And then what about capital spending '08 and '09?

Well, '08 -- I think we are still on target on the CapEx to, we will probably be about 21 to 22 million is where, and that hasn't changed from I think where we were last quarter.

Any meaningful change in '09?

Okay. I am not commenting on '09. But you can look at the trend. I don't think that number should change significantly.

Okay. And then can you put some parameters around Tribotek in terms of size of this, in terms of revenue and purchase price, and things like that?

Yes, I think what we can say on Tribotek, I mean, this is not a material acquisition. I can say that we paid less than, it is less than $2 million, as far as acquisition costs. Basically picked up some product lines, some patents and some customers. And so this is a nice tuck-in for our power business and compliments our bus parts, and sales, and Cableco.

What is nice about that is that we currently are putting some Tribotek connectors on to bus parts, a military application where they require those lower insertion force, and the high [main-to-main] connectability of the connector.

So it was a product line we understood quite well, and really adds to our capabilities when we go in to talk to customers. So it was a good acquisition for us.

And what about your tax rate? It has been jumping around here a bit? Where do you think that finishes here for the year?

I mean, for the full year, we are probably, maybe around the 22% range. That represents, really the results of our strategy to move to lower cost countries and take advantage of the tax benefits that we get from that.

Right.

While it has jumped a bit, up and down, but the trend is that it is lower.

In '09, I mean is that a reasonable number on a go-forward basis then or --

I think that it shouldn't be too much different from that. Again it depends on the mix of business. The domestic business, including TouchSensor and some of the others do well, that is going to shift the effective tax rate up a little bit, but I wouldn't expect it to change significantly, David.

Okay. And then the last thing I have, as we go into '09, you will start to see this business with Chrysler roll off on you, right? As that legacy business rolls off that starts in '09, right?

Yes, that's correct. Yes.

Is it early in the year? Late in the year? Just kind of timing-wise?

Again, probably sometime in the second quarter.

Yes, I think we will start to see that in the second quarter. Again, it depends on mix.

The model change next year?

[multiple speakers]--a 10% reduction a couple of weeks ago.

Okay.

I would anticipate we might see more of that.

And is that still on-track kind to over a two-year plus period to roll off?

Yes, I think we are on plan. Maybe if not a little ahead of plan. We embarked on this a couple of years ago and I think that strategy is paying off for us, and we are seeing our overseas businesses increase, which are more profitable, and our U.S. business has come down.

Yes.

Aside from one-time increases.

Right. Okay. Great. That is all I need. Thank you.

Thank you, David.

Our next question comes from the line of Brian Crawford of Perimeter Capital.

Good morning, gentleman. How are you?

We are fine.

I had a quick question for you regarding just Automotive in general. I know you just mentioned that you are shifting to overseas versus North America, and I also understand that obviously North America is hopeful for a pick-up in the back half of '08, but things are slow. What are you seeing overseas in terms of demand for your products? Could you give a little color as you kind of roll out both this quarter and beyond?

Okay. In Europe, I think we see good demand for the product, because there has not been a demonstrable slowdown in European business for us. I think some of the customers have seen some downturn, but nothing like in the United States. So we are quite pleased with that business, and we expect that to continue.

In Asia, that business has grown. Let me separate out domestic business in China from what we provide General Motors. The Chinese business for us continues to grow, that market continues to grow, although that is a slow growth. A large percentage, but just the number of units produced, are much smaller than Europe or Asia. So while we continue to garner business, we expect that portion to grow slower.

The General Motors business is largely dependent upon how GM does worldwide. We are launching a number of products that not only will ship to the United States, but also throughout Europe. So depending on their sales, it will really dictates how our Chinese company does. So far, that has been good business for us.

And in the United States, I think we are probably a little more conservative than others, but we see it is a tough year for the auto business in the United States. I have seen estimates below 14, or below 15 million units, and that is probably what it is going to be.

I mean, is the majority of your business overseas at this point in automotive, or is it still in North America?

Hang on just a moment and we will get you that.

Yes, we are probably looking at about, right now just looking at the quarter, it is probably 35, yes, 30 -- hold on a minute. I want to make sure that we are looking at the changes. Yes, I mean if I am looking at the percentage of the business. It looks like it is about 40%.

Hold on, Brian.

56 is North American and about 44 is foreign right now.

And Brian, we know what our bookings are through '11, so we know that ratio will change in favor of international business. Now some of that, you have a mix.

And, again some of that depends on if we do have price increases. So you would have to back those out, you get closer to 50/50.

Got it. Thanks, gentlemen.

Thank you.

There are no calls at this time, no further questions.

All right, Anthony, we will complete the call by saying thank you for listening, and everyone have a pleasant day.

This concludes today's teleconference. You may disconnect your line at this time. Thank you for your participation.