Methode Electronics Inc (MEI) 2009 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Methode Electronics, Inc. fiscal 2009 third quarter earnings conference call. At this time, all participants are in a listen-only mode, and a brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

This conference call does contain certain forward-looking statements, which reflect management's expectations regarding future events and operating performance, and speak only as to 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 statements to confirm -- to conform the statements to actual results, or changes in Methode's expectations, on a quarterly basis or otherwise. The forward-looking statements in this conference call involve a number of risks and uncertainties.

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 limitations, the following: (1) dependence on a small number of large consumers within the automotive industry; (2) rising oil prices could affect our automotive consumer future results; (3) the seasonal and cyclical nature of some of our businesses; (4) dependence on the automotive industry; (5) dependence on the appliance, computer and communications industry; (6) intense pricing pressures in the automotive industry; (7) increases in raw material prices; and (8) customary risks related to conducting global operations.

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

Thank you, Paul, and good morning, everyone. Thank you for joining us today for our fiscal 2009 third quarter financial results conference call.

I am joined today by Doug Koman, Chief Financial Officer, and Ron Tsoumas, Methode's Controller. Both Doug and I have comments today, and afterwards we will be pleased to take your questions.

As we discussed last quarter, the increasingly challenging economic situation, and more specifically the severe downturn in the worldwide automotive industry, greatly impacted our results in the third quarter. Additionally, our three and nine-month results were affected by charges relating to our restructuring and goodwill impairment. However, increased penetration in the human machine interface, sensor and power markets in the first nine months of fiscal year 2009 was very encouraging, notwithstanding the severe downturn in our automotive segment.

Specifically, in Methode's third quarter net sales decreased almost 42% to $81 million. Excluding the restructuring charge of $3.8 million, and impairment of goodwill and intangible asset charges of approximately $32 million, Methode's net loss was $0.13 per share in this third quarter compared to a profit of $0.27 in the fiscal 2008 third quarter, with $138 million in net sales, again an almost 42% drop. While the majority of the decrease in revenue was due to lower sales in our automotive segment, our interconnect and power segments were also down due to the slowdown in housing construction and consumer spending. Despite reduced earnings due to in part to impairment and restructuring charges, we still generated $9 million in positive operating cash during the third quarter, and $38 million in the first nine months of fiscal 2009.

Back to automotive. In 2005, long before the current difficulties in the automotive industry, we realized the challenges and issues our legacy automotive business could face, and took actions to reduce Methode's exposure to this business. First, we focused our efforts on engineered solutions in the human machine interface and power categories. Secondly, we made acquisitions to build Methode's innovative and patented portfolio, which increased Methode's percent of revenue covered by patents from approximately 16% in fiscal 2004 to over 28% in fiscal 2008. Thirdly, we began to diversify by region, market and customer, to the extent that we reduced North American revenues to 65% in fiscal 2008, while increasing our European and Asian revenues. We are anticipate that go our fiscal 2009 North American revenues will be even lower.

As a result, during the timeframe, auto-related revenues decreased from 75% of total revenues in fiscal 2005 to 66% of total revenues in fiscal 2008. With the actions we announce today, we expect our automotive revenues to be approximately 40% of total revenues by fiscal 2011. While we have made much progress diversifying Methode away our from our legacy automotive products and customers, our results today indicate that we must accelerate our plans.

During last quarter's conference call, we said that we were holding ongoing discussions with certain automotive customers regarding their significantly reduced volumes. We also told you this might necessitate action on Methode's part to further lessen the company's dependence on this troubled sector. Today, we'd like to discuss the outcome of these discussions to date.

As we announced in the release this morning, we are taking actions in the fourth quarter fiscal 2009, and the first and second quarters 2010, to combat the current economic situation and position Methode for growth and improving results. We are accelerating our strategy to substantially exit our legacy North American auto business, and as I said, reduce total auto revenues to 40% of total revenues by fiscal 2011. We will exit our existing business with Ford North America as currently produced at our facility in Reynosa, Mexico, and move this production to another supplier. This business contributed a substantial portion of the third quarter operating losses. We will continue to manufacture hidden switches and other products for Ford out of our facility in Malta, which is a profitable business for us, largely because we have diversified manufacturing of this location with other European customers. Additionally, we are in discussions with other customers worldwide regarding products which are no longer cost-effective for Methode to produce, due to the slowdown in the global economy.

Although these actions will reduce our revenue performance, they should improve our cash flow position, and allow us to operate with improved margins in fiscal 2010 and beyond. Additionally, we are taking other actions to restructure each of our segments so they are profitable and remain cash flow positive.

As we announced in this morning's release, we are also migrating manufacturing to lower cost regions to consolidate facilities and reduce costs. Moving forward, Methode's principal manufacturing operations will be in Mexico, Malta and China. This restructuring will not only save manufacturing costs, but allow us to combine back office functions and reduce headcount. Additionally, TouchSensor manufacturing, currently in West suburban Chicago, will be moved to our world-class manufacturing facility in Monterey, Mexico, winner of the prestigious Shingo Prize for Manufacturing Excellence a few years ago.

The Company's operations in Shanghai, China will be consolidated to two facilities from three. Power product manufacturing for your European customers will now take place in Methode's Malta facility, where we were awarded grant monies by the Maltese Government to assist with this expansion. It is anticipated that this action will be completed by the end of the second quarter fiscal 2010.

Corporatewide, every division has been asked to reduce overall spending in line with their reduced revenues. In total, this restructuring will affect 850 employees worldwide. Once completed, these actions will allow our management team to focus on growing Methode's business in the product areas I discussed earlier. An additional benefit of the exit of the North American auto business will be reduced capital expenditures for production tooling. We anticipate that this will reduce fiscal 2010 capital expenditures to a range of between $6 million to $8 million.

The estimated pre-tax charge during the fiscal years 2009 and 2010 for these restructuring actions will be between $9 million and $18 million. This equates to between $0.21 and $0.40 per share. The cash portion of this charge will be between $7 million and $8 million. Although the global recession will continue to unfavorably impact the markets Methode serves in the near term, the Company has taken steps to reduce its cost structure and improve its cash flow through restructuring and tighter working capital and capital expenditure management.

While our sales have been impacted by the weakening economic conditions, I am pleased with the significant progress we have made to diversify our customer base and markets. For instance, in the power segment, Methode has been awarded the production contract to provide a laminated bus bar which will be part of the power control system for a hybrid electric vehicle. This new relationship with a major Japanese Tier One for this technology demonstrates our capability to bring an engineered solution to enable these new and emerging propulsion systems, and serves as a launching point for us in the electric and electric hybrid vehicle market. This product will be manufactured in China.

Additionally, we have been contracted to produce a steering sensor for ATVs with a new tri-band sensor technology. You may recall that our MDI technology was used on the Spider 3-wheel motorcycle. Although the award is small from a revenue perspective, this is an example of our technology being able to be propagated across our customers' platforms and applications.

Utilizing technology we gained from our TribaTech acquisition, we'll begin producing a custom power interface for a military application. The customer acquired a highly reliable and efficient high-power product that Methode's technology and know-how, along with our bus bars, made us uniquely qualified to create the engineered solutions for this challenging application.

Methode is working to expand its share of the HMI sensor and power markets by leveraging new products that it has recently acquired or developed, as well as approving our solution-selling capabilities. In the future, we'll continue to look for acquisitions to add to our product portfolio, technical expertise and revenue base, so that we can provide customers with the most complete solutions available in the marketplace. More specifically, as we traverse this increasingly challenging macroeconomic environment, we remain committed to investing in research and development activities to launch new products using our technology.

In summary, Methode's balance sheet, which includes $54 million in cash with no debt and a $75 million line of credit, places the Company in a strong financial position during this recession not only to weather the downturn, but to be opportunistic on prospects which may present themselves.

At this point, I will turn the call over to Doug for his financial review.

Thank you, Don. Good morning, everyone.

I would like to first comment on the goodwill and intangible asset impairment charges that were recorded in the third quarter. One indicator of impairment is whether a company's market capitalization has remained below its net book value for a period of time. That condition existed for Methode during the later portion of the second quarter.

At the end of the second quarter, we disclosed that goodwill impairment was reasonably possible at some of our reporting units, but was not estimable. We disclosed the amount of goodwill associated with the affected reporting units was about $29 million. We completed the analysis under the Statement of Financial Accounting Standards 142 during the third quarter. The final goodwill impairment charge was $18.1 million. We recorded $11.5 million in the interconnect segment, $5.4 million in the power segment and $1.2 million in the other segment.

Additionally in the third quarter, based on our estimate of future undiscounted cash flows, it was determined that certain identifiable intangible assets related to our TouchSensor business unit was also impaired. Therefore, we recorded a $14.6 million impairment charge related to those assets. Given current events and circumstances such as the continued drop in our market capitalization, it is reasonably possible that we may need to record additional impairment charges to either goodwill and/or identifiable intangible assets in the fourth quarter.

We now move to the sales and margin activity for our reporting segments. The automotive segment had third quarter net sales of $36.6 million compared to $88.6 million last year, a 59% decrease in automotive sales. For the nine-month period the automotive segment had net sales of $196.5 million, compared to $261.3 million last year, a 25% decrease in net sales. The decrease is due to the dramatic drop in global vehicle sales, especially in North America, and was also reduced because of reduced Chrysler sales due to our decision to exit this business. In the third quarter, we had about $400,000 of Chrysler sales compared to last year's quarter, where we had $13.2 million. In the nine-month period, we had $14.3 million of Chrysler sales compared to $40.3 million last year.

In the automotive segment, currency fluctuations from sales from our foreign operations decreased the sales by about $800,000 in the third quarter, but for the nine-month period the fluctuations increased sales by about $3.1 million. In the third quarter, gross margins for the automotive segment were $1.9 million compared to $18.9 million last year. For the nine-month period, gross margins for automotive were $35.4 million compared to $53.6 million last year. The third -- in the third quarter, the decrease in gross margin as a percentage of sales dropped to 5.2% from 21.3%. This is primarily due to the inability to reduce overhead costs in line with the significant and sudden drop in sales experienced in the quarter.

In the third quarter, automotive had a pre-tax loss of $2.8 million this quarter compared to a pre-tax income of $13.3 million last year. This is the result of the lower sales volumes, the restructuring charges in this quarter were $2.9 million compared to last year we had $400,000 of restructuring, and these amounts were slightly offset by lower selling and administrative expense. For the nine-month period, pre-tax income was $16.2 million this year compared to $38.3 million last year. Again, this is the result of lower sales volumes, restructuring charges in the nine-month period of $10.4 million compared to $400,000 last year, and offset slightly by lowering selling and administrative expenses.

Moving to the interconnect segment, here we had net sales of $33.2 million in the third quarter, down from $35.6 million last year. For the nine-month period, interconnect had sales of $100.8 million, slightly higher than the $97.2 million last year. Sales were favorably impacted by the Hetronic acquisition, which closed on September 30, 2008. The remaining businesses in the interconnect segment had lower sales in the third quarter and nine-month period. The lower sales reflects the weakness in the global economy, and also our decision to exit the legacy connector business in the fourth quarter of fiscal 2008.

Currency translation decreased foreign sales by about $100,000 in the third quarter, but increased foreign sales by about $600,000 for the nine-month period. Gross margins for interconnect were $7.1 million in the third quarter compared to $7.9 million last year. The decrease is primarily due to the lower sales volumes, offset by the results of the Hetronic acquisition, which has a lower cost of goods sold than the others businesses in the segment. For the nine-month period, gross margins for interconnect were $25 million compared to $22.3 million last year. The increase is primarily the result of the Hetronic acquisition, and again offset by lower sales volumes in the third quarter.

In the third quarter, the interconnect segment had a pre-tax loss of $26.5 million this quarter, compared to a pre-tax income of $900,000 last year. This is due to the goodwill and intangible asset impairment charge of $26.1 million in this segment. We had a restructuring charges of $900,000 this quarter compared to $100,000 last year, and we also had slightly higher selling and administrative expenses. For the nine-month period, interconnect had a pre-tax loss of $28.6 million this year compared to 4.4 -- income of $4.4 million last year. This is the result again of the goodwill and intangible asset impairment charge of $26.1 million, restructuring charges in the nine-month period of $4.6 million compared to $100,000 last year, and because of the Hetronic acquisition we had higher amortization and selling and administrative expenses.

Moving to the power products segment, sales here were $9.2 million in the third quarter compared to $12.5 million last year. This is primarily due to lower demand for bus bar products in North America, offset by increased sales in Asia. For the nine-month period, our product sales were $32.7 million, down slightly from $33.2 million last year. The nine-month period was positively affected by the VEP acquisition that closed on August 31, 2007. Excluding VEP, sales for the power products segment decreased in the nine-month period, primarily because of lower demand for bus bar products in North America.

Gross margins for power products decreased to $1.2 million in the third quarter from $3.6 million last year. For the nine-month period, gross margins decreased to $5.4 million from $9.3 million last year. The reduction in both the quarter and nine-month period is due to a product that reached end-of-life at the end of fiscal 2008, which had higher margins than the business remaining in fiscal 2009. We also experienced an unfavorable mix -- product mix, as well as higher labor and distribution costs in fiscal 2009.

In the third quarter, power products had a pre-tax loss of $5.3 million compared to pre-tax income of $2.6 million last year. This is due to an intangible asset impairment charge of $5.4 million, and lower sales volumes in the current quarter. For the nine-month period, there was a pre-tax loss of $4.1 million this year compared to income of $6.5 million last year. This is the result of the intangible asset impairment charge of $5.4 million, and lower sales volumes in the nine-month period.

In the other segment, third quarter sales were $1.8 million, which is the same as we had last year. For the nine-month period, the other segment had $6.5 million in sales compared to $5 million in sales last year. The increase for the nine-month period is primarily due to higher sales from our torque-sensing business and flat sales from our testing facilities. In the quarter, gross margins decreased to a loss of $200,000 from break-even last year. For the nine-month period, gross margins were $100,000 compared to break-even last year. Both the current quarter and nine-month period were impacted by continued investment initiatives in our torque-sensing business.

In the third quarter, the other segment had a pre-tax loss of $2.1 million this quarter compared to a pre-tax loss of $600,000 last year. This is primarily due to an intangible asset impairment charge of $1.2 million, and higher selling and administrative expense due to our expansion of testing -- a testing lab in Asia. For the nine-month period, the other segment had a pre-tax loss of $3.4 million this year compared to a loss of $1.3 million last year. As with the quarter, this is primarily the result of the intangible asset impairment charge of $1.2 million, and higher selling and administrative expense due to our expansion of testing in Asia. Due to the slowdown in the economy, we have decided to place further investment in the Asia lab on hold.

Moving to the consolidated financial highlights in our earnings release, selling and administrative expense in the third quarter was $14.8 million compared to $17.8 million last year. As a percentage of net sales, selling and administrative expense was 18.3% this quarter compared to 12.9% in last year's quarter. For the nine-month period, selling and administrative expense was $49.7 million compared to $49.8 million last year. As a percentage of net sales, selling and administrative was 14.8% compared to 12.6% in last year's nine-month period. The increase in spending as a percentage is primarily due to higher amortization expense related to the TouchSensor, VEP and Hetronic acquisitions. This was offset by a reduction in compensation expense, since performance targets are not being met under the Company's long-term incentive plans.

Interest income net was $200 million -- $200,000 for the third quarter, compared to $700,000 in last year's quarter. For the nine-month period, the interest income was $1.2 million this year compared to $1.7 million last year. The reduction in the quarter is due to the lower average cash balances and lower nominal yields, and for the nine-month period is down primarily due to lower nominal yields, because we are more heavily invested in tax-exempt municipals this year compared to last year.

Other net was an expense of $300,000 in the third quarter compared to an expense of $900,000 last year. For the nine-month period, other went to income of $1.2 million from an expense of $2.1 million last year. The increase in income is substantially due to the impact of the strengthening dollar on the operations of some of our foreign operations. This was offset by expenses incurred for the reduction in the net asset value of an enhanced cash fund investment in the current quarter and nine-month period.

The effective tax rate in the quarter was a benefit of 33.1% compared to an expense of 13.8% last year. The tax rate for the nine-month period was a benefit of 41.3% compared to an expense of 20.7% last year. The tax rate in both the current quarter and nine-month period reflects the impairment and restructuring charges, and the slowing business in our US-based businesses. Both years reflect utilization of investment tax credits, and the effective lower tax rates at the company's foreign operations.

Now looking at the balance sheet, cash is down to $54.4 million compared to $104.3 million at year end, primarily due to the Hetronic acquisition. Year over year, we had a decrease in cash provided by our operating activities. It was $19.2 million. This was primarily due to the decrease in net income in fiscal 2009, offset by noncash impairment charges for goodwill intangibles and tangible assets. We had a $46.8 million increase in cash used in investing activities. This is primarily due to the Hetronic acquisition in 2009 compared to the smaller VEP acquisition in 2008. We also had less capital spending this year compared to last year. We had an $8 million increase in cash used in financing activities. This was primarily due to repurchase of our common stock in the second quarter, higher cash dividends, and fewer stock options were exercised this year compared to last year.

Continuing on the balance sheet, the accounts receivable balance is $51.3 million, down from $85.8 million at the end of fiscal 2008. This is due to reduced sales, primarily in the third quarter, and we also received a payment on a large customer-funded pooling project. Inventory is $63 million, up from $55.9 million at year end. The increase is primarily due to inventory acquired with the Hetronic acquisition. This was offset by inventory reductions at our other businesses as a result of lower sales.

There was no significant change in the balance of other current assets. We are currently at $14.4 million, and it was $14.8 million at the end of last year. Property plant and equipment net is at $75.1 million. This is down from $90.3 million at the end of last year. About $8 million of the drop is related to accelerated depreciation and impairment due to the restructuring charges taken in the first nine months. $2 million of the drop is due to depreciation expense exceeding capital spending in the nine-month period, and then lastly the balance of about $5 million is due to currency translation of foreign-denominated fixed assets due to the strengthening of the US dollar.

Goodwill is at $50.6 million, down from $54.5 million at year end. This is primarily the result of a goodwill impairment charge recorded in the third quarter, offset by goodwill acquired in the Hetronic acquisition, and additional goodwill reported for am earn out payment on the Cableco acquisition. Intangible assets are at $37.9 million, which is down from $41.3 million down at year end. This is also because of the intangible asset impairment, normal amortization, offset by intangibles acquired with the Hetronic acquisition. Other assets at $39.2 million are up from $23.4 million, primarily related to increased deferred tax assets due to the impairment of goodwill and intangibles, an investment in one of our technology partners, and an increase in the cash surrender value of life insurance policies.

Accounts payable is at $19.9 million versus $42.8 million at year end. It is down primarily due to the lower business levels, offset by payables acquired with the Hetronic acquisition. Other current liabilities are at $21.6 million. This is down from $33.9 million at year end, primarily due to the payment of estimated taxes, payment of severance related to the restructuring, and less bonus and long-term incentive expense being accrued this year versus last year.

Finally, other noncurrent liabilities at $18 million are down from $20.7 million at the year end, primarily due to payments made under the bonus rights plan related to the TouchSensor acquisition, partially offset by increased contributions into the deferred compensation plan.

Don, that concludes my remarks.

Doug, thank you very much.

Paul, we are ready to take questions.

(Operator instructions)

Our first question comes from David Leiker with Robert W. Baird.

Good morning. It is Keith Schiker on the line for David. I just wanted to start with a broader picture question going forward. Don, if we look in the non-automotive businesses, we are about five or six weeks now into the fiscal fourth quarter. How have things trended relative to what you saw in the fiscal third quarter?

That's going to be difficult to answer, because we don't provide guidance. I don't want to say that things have stabilized. I think we are still seeing the -- around the world, I think we are seeing a tough macroeconomic condition. We have seen business over the last six months -- I wouldn't say the last six months, maybe the last five months, drop, and we expect, you know, a very tough calendar year 2009 here. Again, I can't give you more color than that. I would be starting to give you guidance.

Sure. That's helpful. If we look at the $9 million to $18 million of restructuring just announced, if I understood you correctly, that's going to be wrapped up by the second -- or the first half of fiscal 2010. How does that break down by segment, if we wanted to flow that through our model?

I'm just trying to think. We have most of that is automotive, I guess. We have a little bit of it in the interconnect, as Don mentioned. We have got the TouchSensor, we're moving their manufacturing down to Mexico. We also are consolidating the power segment group. So -- but the substantial portion of the charge is going to be in automotive.

Okay. And if we look at the Ford revenue that's going to start -- be transferred in July this year, is there any way that you can quantify how much revenue is going away?

I want to be mindful of our relationship with our customer. I believe Ford has handled this extremely well and very professionally. The revenue in the Reynosa facility from Ford probably, say a year ago, was in the $60 million range, on an annual run rate. And now we didn't do region projections going forward, because we knew we were exiting that business. So we have not taken into account the further reduction in auto sales. But last month, it was running something below $9 million. So -- and losing close to $3 million. And that is probably as much color as I want to give on that. You certainly deserve an answer, but again, I want to be mindful of our customer.

That's very helpful. Then I think if we look towards the fourth quarter, is it unreasonable to expect a big inflow from working capital? And looking forward on the cash flow horizon, what are your thoughts about the dividend?

Well, from a dividend standpoint, we just announced that we were -- our usual dividend of $0.07. But I'm not going to speculate one way or the other what the Board does several quarters from now, or even next quarter, that's up to them. But from a cash --

Yes, I guess the working capital side keep -- I mean, we expect to make some improvements to inventory in -- but that will -- also there is just the timing of the cash portion of the restructuring, you know, may offset the benefit of those improvements there. So I -- you know, I don't know that I can give you a real good answer on that. But that's pretty dynamic. We are going to have a lot of moving pieces for awhile.

Sure. You said $6 million to $8 million CapEx in fiscal 2010. Can you provide any help on a depreciation amortization level? And maybe a tax rate?

Yes. I mean, I -- on the tax rate, I think again we are seeing more of our income shift offshore. So I think our tax rate will continue to be, you know, probably on a normalized basis. I guess I'm struggling a little bit, Keith, because we are going to have some of the restructuring charges that are coming through. Charges, if we do have any more, are going to influence that. But I think otherwise, we should probably see our tax rates still running around -- in that low 20s rate.

Was there another question there?

D&A.

Oh, yes. The CapEx we expect to slow down. The depreciation probably will come down to maybe next year around $17 million.

Okay.

Because you know, we have been -- some of the restructuring has -- we've have eliminated some of the depreciable base.

Okay. That's very helpful. Thank you very much.

Thank you.

(Operator instructions)

We have no further questions in the queue. I would like to turn the call back to Mr. Duda for any closing comments.

All right. Thank you, Paul. We'll just wish everyone a pleasant day, and thank you for listening.

Once again, that does conclude our conference call for today. We thank you for your participation. Have a great day.