Methode Electronics Inc (MEI) 2011 Q2 法說會逐字稿

Greetings. Welcome to the Methode Electronics fiscal 2011 second quarter earnings presentation. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. (Operator Instructions). 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 performances and speaks only as of the date hereof. These forward-looking statements are subject to the Safe Harbor protection provided under the security laws. Methode undertakes no duty to update any forward-looking statements 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. 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 report.

Such factors may include without limitation the following. Dependence on a small number of large customers, including two large automotive customers, dependence on the automotive, appliance, computer, and communications industries, seasonal and said little nature of some of our businesses, dependence on the availability, price, and risk of substitution or counterfeit of components and raw materials. Ability to compete effectively, customary risks related to conducting global operations, ability to keep pace with rapid technology changes, ability to avoid design or manufacturing defects, ability to protect our intellectual property, ability to successfully benefit from acquisitions, currency fluctuations, unfavorable tax laws, and the future trading price of our stock.

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

Thank you, Christine, and good morning everyone. Thank you for joining us today for our fiscal 2011 second quarter financial results conference call. I am joined today by Doug Koman, Chief Financial Officer, and Ron Tsoumas, Controller. Both Doug and I have comments today, and afterwards we will be pleased to take your questions.

This morning I am pleased to report that in the second quarter of fiscal 2011, Methode continued to post strong net sales, which improved 8.2% year-over-year, and 8.5% sequentially over the first quarter. Led by improved sales in our Asian automotive and power product segments, as well as in our North American and European interconnect segments.

We achieved this revenue improvement despite the loss of the Delphi business, which represented $6.6 million in sales in the second quarter of last year, and planned lower legacy automotive product sales of $3.9 million, Excluding these two items from the year-over-year comparison, second quarter fiscal 2011 sales increased $18.6 million or in excess of 21% over last year, which I believe reflects the true measure of our success.

For the first six months of fiscal 2011, net sales increased 8.8%, compared to the same period of fiscal 2010. Excluding the loss of $14.1 million in sales for Delphi and planned lower legacy automotive product sales of $10.2 million, sales increased $40.9 million, or almost 25%. As we announced this morning, Methode recorded an expense of $3.8 million in the second quarter for unsecured claims Methode had filed against Delphi in Delphi's bankruptcy proceedings, which we sold to Credit Suisse in 2006, and they subsequently assigned to Blue Angel.

We recorded those expenses mandated by accounting rules, although we believe we have defenses to the complaint. This expense had a considerable negative impact on earnings in the second quarter of fiscal 2011 and is a derivative of the unusual manner in which Delphi filed and served their preference complaints. Additionally, we had several other charges and costs for the second quarter that makes an apples to apples comparison a little difficult. Doug will expand upon these in his discussion, but let me give you a brief overview.

Consolidated gross margins were 22.1% in both fiscal 2011 and 2010 second quarters. Even though our sales increased year over year, gross margins in the second quarter remained constant due to the loss of sales of Delphi, which was a higher margin business line for us. And on negotiated program determination charge, which was part of the negotiations on the recent major program award. For these same reasons, consolidated gross margins were down 1% in the first half of fiscal 2011.

Moving on to the segment results. In the second quarter, automotive segment sales were down 2.5% year over year, again mainly due to loss of the sales to Delphi and the planned lower legacy automotive product sales. If we take these two items out of the second quarter, automotive segment net sales increased almost 20%. Again, excluding Delphi and legacy automotive, sales in the six-month period, net sales increased over 25% year over year.

If we also exclude the planned transfer of manufacturing of the T-76 lead frame product to China, North American automotive segment sales increased 40%, and Asian sales increased 63% in the second quarter. This is primarily the result of the upturn in the US automotive market.

Sequentially, second quarter, second-quarter automotive sales were up more than 11% over the first quarter. Automotive segment gross margins in the second quarter and first half were negatively impacted by the loss of the higher-margin sales of Delphi, as well as other charges and costs in the quarter. As we launch more programs, margins should improve.

As we have said in previous calls, we expect the MyFord Test Center Console program will ramp in the third quarter. We also expect the lead frame business to continue to do well. As such, we expect second-half automotive sales to mirror the first half.

Interconnect sales increased almost 20% in the second quarter, and nearly 29% in the first six months. This is attributable to solid growth in the interface solutions and data solution businesses. Sequentially, second-quarter interconnect sales were up 5.7% over the first quarter. However, interconnect sales may be flat to slightly down sequentially in the second half, as we are expecting some softening in appliance sales. Interconnect margins in the second quarter and first half exceeded our target margins for this business, due primarily to higher sales volume and a good sales mix.

Power product sales were up almost 28% in the second quarter, and nearly 15% in the first half. Driven mainly by higher demand for Buspar products in Asia and North America. Sequentially, second-quarter power product sales were up over 4% over the first quarter. Gross margins decreased year over year in the second quarter due to a customer program cancellation, and associated expenses, which we are seeking to recover, as well as from higher costs related to new product development. As we said last quarter, the majority of power business awarded in the last six to 12 months will launch in fiscal 2012 is higher-margin business. As such, we expect the segment's margins to improve over time.

Onto new business wins and ongoing solutions development for our customers. In the third quarter of last fiscal year, we told you about several opportunities in our North American automotive business, which represented significant future revenue potential, more than $100 million annually. Thus far this fiscal year, we have been awarded three of these opportunities with the remaining three still evolving.

First, as announced last month, we were awarded the next generation center stack program for multiple General Motors vehicle platforms, starting in model year 2013, with an expected five-year program life. This program is expected to represent over $57 million in fiscal 2013 revenues, and over $100 million in revenues per year starting fiscal 2014. Additionally, we were awarded a small center console program for Kia and have produced a prototype center console for Hyundai. Methode won these programs because of our innovative work with Ford on the center consoles and its MyFord Touch platforms, and because of the unique touch-screens we developed for our premium appliance customers. Methode's technology and solutions in both the automotive and appliance market allowed us to provide a complete solution for these automotive OEMs.

Second, we booked additional T-76 transmission lead frame business with our current customer. This award represents more than $17 million in revenue beginning in fiscal 2012, peaking to $21 million in fiscal 2013. We continue to pursue additional lead frame opportunities with other domestic and European OEMs.

Third, we were awarded a prototype program for major Asian OEM, using our biometric sensor for driver identification to authorize telematic transactions. The other three opportunities we discussed in North American automotive, which are still evolving all utilize our MDI technology. We will keep you apprised of these opportunities.

Beyond those opportunities and also in MDI, we are launching a sensor to be used in on E-bikes in Europe. E-bikes are traditional pedal bikes with an electric motor which provides electronic pedal assist, but still can be riden on bike paths in Europe. Our MDI sensor determines how hard the biker is working, which allows the optimum amount of mechanical support. For instance, if a wind comes up the E-biker must pedal harder to maintain the same speed. The sensor reacts to this and extra power from the motor is supplied. This program could represent in excess of $2 million in revenue in fiscal 2012 and demonstrates the versatility of the MDI technology.

In user interface, Methode was contracted by a leading worldwide manufacturer of welding equipment to develop a concept for multifeatured UI panel to be used across a wide range of welding machines. Already a Methode UI and power customer, we had approached this customer to demonstrate the rest of our technology toolbox. It turned out that our touchscreen technology was of key interest for this customer, because of its robustness for the environments in which welders must operate.

Also in user interface, we are pursuing two opportunities utilizing our multispectral imaging biometric sensors. One with a forklift company as part of their operator identification system, and the other for a company involved in fleet management. Both companies have commented that our Lumedyne biometric sensor is the most robust they have seen.

Finally, in power, we are working with a military contractor on an auxiliary power unit which utilizes several products from our power solutions group. It is important to note that the majority of these additional awards we received in this fiscal year won't hit our revenue line until fiscal 2014, as it takes 18 to 24 months from the date of award to the launch of a program, and about 36 months to reach full production of volume. We continue to rebuild our revenue stream by serving large growth markets, by providing solutions that deliver genuine value for our customers, and higher margins for our shareholders, and by focusing on innovation and integration of patented technology.

Our goal is to reach our historical revenue high of $551 million in fiscal 2014, which includes all the new business wins we discussed today. In summary, we are encouraged by our sales improvement in the first half of fiscal 2011, and at this point, expect similar results in the second half. Now, I will turn the call over to Doug, who will provide further details regarding our financial results. Doug?

Thank you, Don. Good morning, everyone. I am going to keep my comments brief today, since we provided detailed information about our consolidated and segment results in both our earnings release and 10-Q filings. Don mentioned that we had some significant items in both the current and last year's results that make for a difficult apples to apples comparison.

Let me walk you through some non-GAAP adjustments. For the second quarter, we reported a net loss of a $0.5 million or $0.01 per share. This compares to net income of $2.1 million or $0.06 per share in last year's quarter. Excluding the $3.8 million Blue Angel charge and the negotiated program termination charge of $1.3 million, the current quarter's net income would be $4.6 million or $0.12 per share.

In last year's results, if we excluded the negative effect of the $3.2 million of restructuring charges and the offsetting favorable effect of reversing a $1.7 million one-time pricing accrual, than last year's second-quarter net income would have been $3.5 million or $0.10 per share. Therefore, on an adjusted non-GAAP basis, net income was $4.6 million this quarter compared to $3.5 million last year's quarter, or $0.12 per share this quarter versus $0.10 last year.

For the six-month period, we reported net income of $3.6 million or $0.10 per share. This compares to $2 million or $0.06 per share in last year's six-month period. Excluding the $3.8 million Blue Angel charge and the negotiated program termination charge of $1.3 million in the current six-month period, net income would be $8.7 million or $0.23 per share. If last year's results excluded the negative effect of $6.8 million of restructuring charges and the favorable effect of reversing a $1.7 million one-time pricing accrual, than last year's six-month period net income would have been $7.1 million or $0.19 per share. So, on a non-GAAP basis, net income was $8.7 million in the current six-month period compared to $7.1 million last year or $0.23 versus $0.19.

Just some comments on cost of products sold. In the current quarter, as a percentage of sales, it was 78.9% compared to 79% last year. The comparison would've been better this year except for a few unusual items in the current quarter such as the negotiated program cancellation charge of $1.3 million. We had some vendors supply issues on new product launch, that was about $600,000. We had a customer cancellation charge of $400,000 and we incurred slightly higher environmental charges this year, about $300,000. So those negatively impacted the cost of products sold as a percent of sales this year.

Likewise, in the six-month period, cost of products sold as a percent of sales was 79.5% this year compared to 79% last year. Again, the comparison would've been better except for the negotiated program cancellation charge, vendor supply issues on the new product launch, which were about $700,000 in the six-month period, the customer cancellation charge, and about $0.5 million of additional higher environmental charges this year versus last year's six-month period.

Looking at selling and administrative expense. In the quarter, selling and administrative as a percent of sales was 19.9% compared to 16.6% last year. If you just removed the Blue Angel charge, then selling and administrative this year would have dropped to 16.3%, which is slightly below last year 16.6%. This is encouraging, especially since we are incurring slightly higher selling and administrative costs in the automotive segment to support some of the future growth.

For the six-month period selling in administrative expense as a percent of sales was 18.3%. This compares to 17.2% last year. Again, if you exclude the Blue Angel charge in this year's six-month period, as a percent of sales, selling and administrative would have been 16.4% compared to 17.2% last year.

I wanted to point out that in the quarter, we did borrow $18 million under our credit facility. Currently, most of our cash is located outside of the US and while we expect to generate cash in the US through future domestic operations and through the collection of refundable income tax and other cash repatriation methods, it may be necessary to borrow from our foreign affiliates or to borrow again under the credit facility for the near-term.

In the quarter, we recorded a foreign exchange loss of approximately $2 million. This was primarily the result of the weakening of the dollar versus the euro. During the second quarter, the US dollar to euro went from a high of EUR0.79 to a low of EUR0.71. That's about a 10% swing, so that significantly impacted our results. The encouraging news is that based on the recent strengthening of the dollar to the euro, since the end of the quarter, the USD to euro has come back to as high as EUR0.77, so we'll be looking to opportunistic and lock in those days when appropriate during the second half of the year.

Just finally a comment on operating cash. During the first six months, we generated $3.8 million cash from operating activities. However, this was about $11.8 million less than we generated in last year's six-month period. This was primarily due to the change in working capital.

Again, the change in working capital is primarily attributable to the higher sales activity, so we saw an increase in accounts receivable and inventory. This is partially offset by an increase in accounts payable. Additionally, the increase in inventory was also occurring because we were carrying some higher inventory for certain components that had been in short supply in the market place. Don, that concludes my remarks.

All right. Thank you, Doug. Christine, we are ready to take questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). One moment, please, while we poll for questions. Thank you. Our first question is from Jeremy Hellman with Divine Capital Markets. Please proceed with your question.

Good morning, guys. Congrats on the nice quarter. Thanks also for putting out that 10-Q earlier. I like that. It makes my job easy. A number of things on my end. I'm just trying to get to what is, if you will, a normalized SG&A expense level. If you back out Blue Angel, that gets it down to $17.5 million for the quarter, and then there were the program termination costs and writedowns of vendor supplies. That's another $2.6 million or so. Am I right in thinking that will be backed out getting me down to about $15 million or so for kind of a base SG&A level?

Jeremy, I didn't quite hear you. What were you backing out?

Blue Angel and $1.3 million of program termination costs, $0.7 million--?

Jeremy, those are in cost of products.

That's right. I actually had my question upside down then. If I back those out of cost of products sold, that comes out to about 4.7% of revenues. For the auto gross margin, you say it is going to tick up anyway based on what you've got coming in the pipe, but that gets it up to around 22 and change is kind of a go forward basis for gross margin. Am I thinking about that right?

I think we have said that we were in the -- going forward, probably the high teens. I don't know that I would go as high as that, what you've taken out there. I don't think we'll see that. I think high teens is still a good--.

Okay. Kind of thinking about the margins again, you mentioned your 2014 goal of hitting that $551 million revenue target. Do you have any kind of framework around, where you would like margins to be with that revenue?

I would refer you to the -- are you talking about gross margins?

Whichever margins you'd care to comment on. EBITDA gross, gross margins, net margin if you want to go that far.

I will let you go from the gross margin line down. I would use what we have put out recently on the gross margin ranges by segment.

Okay. Legal expense I think in the Q, mentioned that has come down a bit. How much was legal expense in the quarter?

It was $600,000.

Okay.

I'm sorry, it was $600,000 less -- I'm sorry. It wasn't $600,000. $600,000 less than last year. As we commented, that will be in peaks and valleys.

Sure. Is there anything in his quarter that is currently scheduled that you would look to skew it in his quarter?

No. Actually, it's hard to predict. No.

Okay. One last one for me and I'll jump back. Have you seen anything that would cause you to change your assumptions with Ford and the MyFord Touch, worth about $12 million second half this year, ramping to $40 million next year and beyond?

We have had a good launch with them from the standpoint of them filling their pipeline. They had a delayed launch, so they kicked it into high gear recently. We are probably going to be into the midteens. I think we said $12 million. I think we will be in the midteens for the year. That is going to uptick slightly in the second half.

Okay. And then looking at next year, any--?

I don't know if I want to go that far. Let's just see how the product's received in the marketplace.

Okay. Thanks.

Thanks, Jeremy.

(Operator Instructions). Our next question is from David Leiker with Robert W. Baird. Please proceed with your question.

Good morning. It's Keith Schicker on the line for David.

Hi, Keith.

If I step back, it looks like the quarter came in better than what you guys were initially looking for, and the outlook provided in the last 10-Q. Could you just comment on if indeed that is the case or how the results compare with what your initial expectations were and maybe what the swing factors were one way or another that pushed it higher or lower?

Certainly, in automotive we benefited from the uptick in the US automotive business. That drove in our Asian sales of 270, lead frame sales were really good. String angle sensor business, we're talking out of Asia was quite good. That really helped us interconnect, which is a little harder to forecast, was stronger. I think, this is kind of a -- maybe a better than expected take rate from our customers across the board certainly benefited us.

Okay. And then if I look at some of the items -- the vendor supply agreement and the customer cancellation, A, if I want to back those out of the numbers, is there any tax effect that I need to consider there? And B, are those things that you would expect to continue going forward, or are those just one-time items during this quarter?

David, the customer cancellation, those kind of happen all the time. We just commented on that because it did have an impact year-over-year.

Was at the customer cancellation or--?

The negotiated program charges, it was different, because that was kind of a quid pro quo as Don mentioned in his comments in order to win some new business. That one we consider that is more one-time. I don't think we've seen that before.

As far as the tax on that, that happened to be business in Malta. And in Malta, there is no tax impact. Both pre- and post-tax, it's the same amount. Likewise, on -- you're going to ask about the Blue Angel in the US because of our situation with net operating losses, we have taken full valuation allowance on that, so there is no tax benefit to be recorded on that.

And then the vendor supply agreement, is this component shortages, maybe we've heard other suppliers talk about electronic component shortages. Is that what the issue is there?

Not in that case. It was just really a capacity issue at the supplier. They ran into problems. We incurred premium freight, and significant overtime. You can treat that as one-time, but every couple of years, you have something like that. It is not something that you have routinely. But occasionally, a supplier has a problem and the last one was, what, five years ago, maybe with Stepco with when they went under. I will leave that up to you to decide.

Okay. And then if I look at the Legacy business and the Delphi business, are we through the point now where that is out of the prior year comparisons right now, and that is not going to be something that depresses the year-over-year revenue growth comparison? Is there still a little bit more to roll off?

Going into third quarter, fourth quarter, it will be a good comparison. But obviously, the year-to-date will have a little bit in it.

Okay. And then, Don, I got caught up with one of your comments before that the new T-76 lead frame business, is that something that is just newly announced this quarter, or was that discussed the last quarter when you reported earnings as well?

We discussed it last quarter. I wanted to update from third quarter of last year where we had listed out the opportunities.

Okay.

Those are all included in the numbers you saw at the Baird conference.

Okay. It looks like that revenue opportunity went up a little bit though. You're talking about $38 million now. I thought we had written down $20 million last quarter. Maybe I need to follow up off-line.

Let's follow up on that. It may just be the difference in the fiscal year. Let us look at that.

Okay. That's all I have for now. Thank you.

Thank you, Keith.

Mr. Duda, there are no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Thank you, Christine. That will conclude the call. We wish everyone a very pleasant and safe holiday season. Thank you.

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