Methode Electronics Inc (MEI) 2013 Q2 法說會逐字稿

Welcome to the Methode Electronics fiscal 2013 second-quarter 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 does contain certain forward-looking statements, which reflects management's expectations regarding future events and operating performances 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 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 reports.

Such factors may include, without limitations, the following--dependence on a small number of large customers, including two large automotive customers; dependence on the automotive, appliance, computer, and communications industries; further downturns in the automotive industry, or the bankruptcy of certain automotive customers; ability to compete effectively; customary risks related to conducting global operations; dependence on the availability and price of raw materials; dependence on our supply chain; ability to keep pace with rapid technological changes; ability to improve gross margins due to a variety of factors; ability to avoid design or manufacturing defects; ability to protect our intellectual property; ability to withstand price pressure; the usage of a significant amount of our cash and resources to launch new North American automotive programs; location of a significant amount of cash outside of the US; currency fluctuations; ability to successfully benefit from acquisitions and divestitures; ability to withstand business interruptions; income tax rate fluctuations; ability to implement and profit from the newly acquired technology; 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. Thank you, Mr. Duda. You may begin.

Thank you, Kevin, and good morning, everyone. Thank you for joining us today for our fiscal 2013 second-quarter financial results conference call. I'm joined today by Doug Koman, Chief Financial Officer, and Ron Tsoumas, Controller. Both Doug and I have comments, and afterwards, we will be pleased to take your questions. Methode's second-quarter sales grew 12% to $130 million, and in the first six months of fiscal 2013, net sales increased nearly 10% to $249 million. In both periods, improved volumes were driven mainly by increased sales of the Ford center console program and lead-frame assembly products; new product launches in our European automotive business; torque-sensing product sales for e-bikes, motorcycles, and ATVs; as well as higher appliance and data solutions sales. These sales improvements were partially offset by softness in our Power Products segment.

As we announced this morning, we received half of the $20 million litigation settlement in October and will receive the other half in January of next year. We recorded the entire gain in the second quarter in the income from settlement section of the income statement. Excluding the impact of the litigation settlement, Methode's second-quarter net income is $5 million, or $0.13 per share, from $0.01 last year, and its first-half net income is $8.8 million, or $0.23 per share, compared to $0.05 last year. The earnings improvement was driven by higher overall sales volume; lower selling and administrative expenses; the one-time reversal of accruals related to a customer bankruptcy; higher other segment income; commodity pricing adjustments; and lower legal expenses. Second-quarter earnings were negatively impacted this year by higher costs related to the design, development, engineering, and launch of the General Motors center console program; higher income tax expenses; the absence of a gain on the acquisition of AMD, from which we benefited last year; costs related to the delayed launch of a laundry program; as well as manufacturing efficiencies, lower sales, and an unfavorable product mix within the Power Products segment.

Costs related to the design, development, and launch of the General Motors center console program for the next-generation truck platform lowered second-quarter net income by approximately $2 million, or $0.05 per share, and lowered first-half net income by $3.4 million, or $0.09 per share. In fiscal 2013, we anticipate approximately $4.5 million in total launch costs for the program, with the majority of those costs having already occurred in the first half. Consolidated gross margins fell about 1% in the second quarter and less than 1% in the first six months compared to the same periods of last year. The decrease was due primarily to increased design, development, and engineering costs for the General Motors center console program, as well as increased sales of the Ford center console program, which carries a higher prime cost due to the high purchase content. Additionally, the delayed launch of a laundry program in the Interconnect segment, as well as manufacturing inefficiencies and an unfavorable product mix in the Power Products segment, negatively impacted our second-quarter and first-half gross margins.

The development launch costs for the General Motors center console program lowered Automotive second-quarter gross margins by 2.5 percentage points and the first six months gross margin by 2.2 percentage points. As I mentioned last quarter, we are successfully producing all of the decorative components for Ford's D car platform. However, due to higher-than-anticipated volumes of U car, we continue to utilize the outside suppliers to supplement our production in the second quarter. While our charges for inspection and freight were lower this quarter over last year, we anticipate incurring charges in the third quarter as we ramp up to meet Ford's demand.

In our release today, we announced that we anticipate sequentially lower sales and earnings in our third quarter compared to the second quarter due to weakening demand over the last few weeks in our European Automotive segment, as well as reduced sales in the Power Products segment. As such, we now expect third-quarter earnings per share to be breakeven to modestly profitable. Additionally, based on what we are seeing in Europe, we now anticipate sales and earnings for fiscal 2013 to be at the low end of our guidance range of sales of $470 million to $500 million, and earnings-per-share in the range of $0.45 to $0.60. This guidance excludes the income from the litigation settlement. This would indicate that we are anticipating a strong fourth quarter, which is based on the initial launch of the General Motors [K2XX] program. New launches in European Automotive, which are being delayed by the customer from our third quarter, now launching in the fourth quarter. Our fourth quarter is a full 13 weeks with no holidays, and generally, we see strong OEM demand in our fourth quarter. That said, there is considerable volatility in the European market.

Now turning to review of our individual segments. Automotive segment and sales increased nearly 19% in the second quarter and grew 16% in the first half, due to higher sales of the Ford center console program and our transmission lead-frame product, as well as new product launches in Europe. Automotive segment gross margin decreased in the second quarter and first half, impacted by the higher prime cost for the Ford center console program, as well as costs related to the launch of the General Motors program, partially offset by lower costs related to third-party inspection costs, premium freight, and overtime expenses, and a commodity price adjustment. In our third quarter, we believe our European Automotive segment will be impacted by several factors. First, the economic conditions in Europe. Second, the delayed launches, and finally, reduced volumes on the new [EV] programs.

Moving to Interconnect sales, increased almost 6% in the second quarter and nearly 2% in the first half, attributable mainly to improved appliance and data solutions sales, partially offset by lower sales of radio remote controls, as well as the planned exit of a product line at our Asian operation. Appliance sales improved in the first half due mainly to the successful launch of the first phase of the laundry program in October. However, due to a customer-driven delay, the remaining three phases of the launch are now expected to occur in the first quarter of fiscal 2014. We anticipate this program to be at a slow run rate in the second half of our fiscal 2014.

As I mentioned last quarter, radio remote control sales decreased in Europe due partially to lack of sales to a financially distressed distributor. To remedy the situation in September, we acquired certain assets of the distributor and will operate this business under the name Hetronic, Italy. Additionally, an overall ongoing weakness in the European economy impacted second quarter Hetronic sales, as several of our customers saw softer demand in their end markets. Interconnect's gross margins were relatively stable in the second quarter and first half, due mainly to higher sales for appliances and data solution products, offset by development costs for the laundry platform.

Our Power Products segment saw 9% and 7% lower sales in the second quarter and first half, respectfully, due mainly to significant reduced military spending; a major project with Cisco going end-of-life sooner than we anticipated; as well as the delay of new programs, such as domestic EV programs; and in general, much lower volumes than we originally anticipated. However, our design and success with Power Products on data center service has offset some of the weakness in industrial and military accounts due to the economy and government budget cutbacks. At this point, we anticipate continued softness in the second half for the segment. Power Products gross margins decreased in the second quarter and first half, mainly as a result of manufacturing inefficiencies, lower sales, and an unfavorable product mix. Without the new-product development costs for [eTrex], gross margins would have been 18% and 19% in the second quarter and first half, respectfully.

Now let me summarize some of the new-product development and new business awards and opportunities that occurred in the second quarter. In our North American Automotive segment, we have been awarded the capacitive touch screen for a portion of General Motors K2XX, as well as all of the vehicles in the [31XX] platforms, replacing the eight-inch resistive touch screen we are currently purchasing from a third party. This will be a running change for the K2XX platform beginning in July of 2014, and 31XX will launch with our capacitive touch screen. This is Methode's first major award with the capacitive touch screen and [should improve] the margins for the General Motors center console program. We are utilizing this award to discuss additional capacitive business opportunities with General Motors, as well as opportunities with other OEMs.

This is another example where a technology developed by another Methode division, in this case TouchSensor, has been successfully marketed in Automotive, as well as being refined to meet stringent automotive specifications. In our European Automotive segment, we booked several new programs, including electronic part brake assembly, as well as hidden, window lift, and tailgate switches for various European OEMs. Together, these programs represent approximately $8 million to $10 million in new annual revenue beginning in fiscal 2015. Hetronic's [explosive proof] market penetration continues to expand with the addition of a new major customer in Brazil, who awarded their first systems. Further, Hetronic received several new European industry certifications for various products, including its new explosive-proof battery, and most importantly, for railway products in Europe.

So to quickly summarize, although we had a strong first half of fiscal 2013, the third quarter will likely be weaker as the impact of economic turmoil and downturn in Europe begins to impact us. However, we do expect an improved fourth quarter over third quarter with the General Motors center console program launching and other European automotive programs moving to full launch. On an aside, our launch and production teams continue to do an excellent job of managing all our projects under development and moving those towards a successful launch. We commend them for their very fine efforts. 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. Let me add just a few additional comments to those Don has already made. The effective tax rate for the second quarter was 12.2%, which resulted in an income tax expense of $3.3 million for the second quarter. If the Delphi settlement were excluded from the second-quarter pretax income and from the tax rate calculation, the effective tax rate would have been 25.1% and would've resulted in an income tax expense of about $1.7 million for the quarter. Looking at CapEx in the first six months, we spent $23.6 million. As we have said previously, most of our capital spending would be in the first half of the year. For the full year, we now expect capital spending to be between $28 million to $31 million. Depreciation and amortization expense in the first six months was $8.8 million. In fiscal 2013, we expect full-year depreciation and amortization to be between $18 million to $20 million, as we replace a significant amount of assets in service in the last quarter of the fiscal year.

As Don mentioned, consolidated net sales were up $13.9 million, or 12%, this quarter versus last year. However, sales were negatively affected by $2 million, or 1.5%, due to currency fluctuations, primarily due to the weakening of euro against the dollar. For the six-month period, sales were up $21.8 million, or 9.6%, over last year. Likewise, the six-month sales were negatively affected by about $2.4 million, or 2%, also due primarily to the weak euro. Operating cash was $22.7 million for the six months, compared to $1.7 million last year. We had higher net income, which included $20 million from the Delphi settlement. However, $10 million of that is yet to be collected.

We also saw improved working-capital management in the first six months of this year compared to last year. We brought bank debt down $10.5 million in the quarter to $46 million at the end of the second quarter. You should recall that in the fourth quarter of fiscal 2012, we identified $38 million of undistributed foreign earnings for repatriation as a dividend. The cash was repatriated to the US in the last week of our second quarter of fiscal 2013. A portion of this was used to reduce borrowings in the second quarter, and it will also reduce the amount of borrowing required for the remainder of the year and will otherwise be used for operating and capital needs. Don, that concludes my comments.

Doug, thank you very much. Kevin, we are ready to take questions.

Thank you. We will now be conducting a question-and-answer session.

(Operator Instructions)

Jamie Baker, B. Riley & Company.

Thank you. The inefficiencies that [dinged your] Power Products margins here in the quarter, along with mix, can you talk about your expectations for a continuation of those dynamics for the balance of the year? Or should we see more significant margin improvement in that business come fourth quarter?

At this point, we are going to -- let me back up. Our military and aerospace products in general carry much higher margin than our other products in Power, the data center products as well as some of the telcom. At this point, we are going to see that mix probably stay more towards the lower-margin products. For the duration of the year, I think we are going to see really more of the same. I think we said that in the prepared remarks. And then we are taking a look at what steps do we need to take to adjust that business for what we think is going to be a continued downturn in the military spending going forward. Now we've got new products coming out, but I think there's just a general softness that, that business is going to have a headwind for at least the next 6 months, maybe even 12 months.

Okay, that's helpful. More generally, your guidance obviously implies a pretty healthy fourth quarter. Can you talk about your comfort level with your European business there in the April quarter? Trying to get a handle on what level of visibility you have there and how conservative you are being?

In general, at least a quarter in advance, we have pretty good visibility into the releases. In normal times, those [will come] fairly reliable. You don't see much variation. Europe is not unlike what we saw in say, 2008, 2009, in the US automotive business, where there is quite a bit of variability in the market as OEMs adjusted to their demand. So we've looked at our releases. We know we are launching more products and [work with the overall] launch at a lower rate. And we feel confident that those are good numbers at this point.

But if we see further declines in the European economy, then that confidence is of course much less, as we're at the mercy of what the OEMs are going to take from us. So I would say there's a degree of caution. There's also a degree of conservatism and as we look at Europe and those numbers. We're also launching for the initial launch of K2, which will ramp -- we'll be building inventory beginning in our fourth quarter, and then ultimately selling product I think in the last month as scheduled. The fourth quarter is usually our strongest quarter. It's 13 weeks, no holidays, and it's a strong OEM build season. So with all of that, we know that the fourth quarter will certainly be well improved over what we're showing in the third quarter. [Anyhow], third quarter has December in it and the holiday shutdown.

Of course. Sure. Understood. Thanks very much for the time. Appreciate it.

David Leiker, Robert W. Baird.

Hi, good morning, guys, This is Joe on the line for David. Want to circle back on what you were saying with Europe. Can you give us a better sense of when you are seeing the production cuts come? Is it December? Are they going to take a full two weeks of holiday downtime? Is it more January? And then I'm wondering is this broad-based weakness across all the auto makers? Because I know you typically supply a more-than-normal share of the super-premium segment with a McLaren or an Aston Martin or even Jaguar. So is it broad-based across the auto makers or more customer-specific to Methode?

It would be more customer-specific. We have [Ceot], Renault, the Peugeot. We're also seeing the volume on the Leaf vehicle. Those are ramping at a slower pace. And the Volkswagen is up for us. Really, if you look at quarter over quarter what auto makers in Europe [will have effect] we are tracking that almost one-for-one. [In PF down], we are down. Premium, that hasn't seen a large downturn. But the significant reductions are in Ceot and Renault and Peugeot.

Okay, and --

I don't have [and to try to ] answer the second question, I don't have with me what that effect is on a monthly basis, but we certainly have that.

Okay, maybe I can circle back offline. Thinking about -- I understand your business is normally strong because Q1 production, especially in North America, is normally strong. I'm wondering are there any concerns, given that GM has very visibly built up a lot of inventory, that you're really going to be sitting on declines there at GM? So your normal Q4 is a function of how strong Ford might be?

That's a good question, but I would say that will have a -- a higher inventory will have an effect later on. GM, as well as Methode, will be doing a pipeline sale on the new pickup truck line. So if there is an effect, I would think that would come later. And we are really in daily contact with GM and monitor -- we're near a launch. So we're looking at volumes. We're looking at [run] rates. That could always change, but I think it would really affect maybe our first or second quarters of next year. And it is one month, also.

Sure. And then my last one. As we think about the K2XX launch, so you are incurring costs right now without any revenues. As we head towards your Q4, you will start to get some initial volume but probably not enough to absorb all your overhead. I'm wondering when do we really hit full stride in the launch cadence so that K2XX is additive to your profits? When would you envision that run rate happens?

In the first quarter of fiscal 2014.

Okay.

At that point, truck is fully launched. And then later on in '14, SUV will launch. But truck will be fully launched. And again, that's all -- there is no take rate on that. It's all trucks.

What would be -- would the target margin by fiscal Q1 be in line with the rest of your auto business? Or would you expect it to already be above, given that -- would you be doing the touch screens on the initial truck volumes as well?

No, the touch screens will be [a running] change. What did we say? In 2014.

Okay.

So that won't have an effect on next year.

Okay got it. Then I actually have a housekeeping item for Doug. Do you have a sense of what tax rate you might expect towards the back half, given it seems like your income is going to be skewed more towards the US?

Yes, we do take a look at what the full-year effective tax rate looks like. And based on where we sit today, I think we were at -- again, we had a couple of discrete items, but I think we were at 12.2%. So that's probably -- that would be the good rate for the full year to use.

Okay. I'll leave it there. Thanks a lot, guys.

Greg Macosko, Lord Abbett and Company.

Yes, thank you. With regard to some of the programs, like the launch of the laundry platform, which has been delayed, and is that -- I would assume that would be affecting sales primarily in the fiscal '14. Is that right? Or am I -- is that how I would look at it?

Yes, the launch has been delayed, at the last three phases, to our fiscal '14. That should be ramping in our first quarter and then reaching its peak in the second quarter.

Okay. And that was originally expected when?

Really, ramping now.

Okay.

It begins -- I shouldn't say -- launching now and ramping in the fourth quarter. So we're really shifted two quarters.

I see. And that's just recent, I assume. Right?

Right. And I think we announced that in November 5.

Okay. All right. Yes, fine. With regard to the weakness in the Power Products, I guess that's primarily military driven, right?

Yes, for the most part, but we also were providing Cisco a product for their high-end servers, and that they took end-of-life sooner. That wasn't anticipated, and that was a good-margin product as well. But it's really the military that is down. And we had an EV program that should have been fully ramped now, and that's much slower, and that's mainly because of the EV market and that being where everybody anticipated. Again, the main factor is the military spending, but the other two certainly have an effect. We are taking a look at what that business is going to be like over the next 6 to 12 months and how do we position it so that we take into account what I think will be a slower spend in military for at least the next couple of years.

So you're, in other words, looking at the manufacturing and capacity and those kinds of things for the next near term?

What we do I think fairly well is we adjust our expenses in line with the revenues that we expect. And the revenues aren't materializing as we once thought, so we will make the appropriate adjustments. We have actually started to do that.

Was the military a surprise, or was that --?

I wouldn't say it was a surprise. The volumes in general were lower than we expected, but for months now been in the process -- there's military spending cuts. And the new programs, which are funded, are ramping the volume much lower. I think that I talked about lessons learned on our business. I think as we go forward, we are going to look at these programs. Even though we generally think we are conservative in what the volumes are going to be, we probably need to, at least in the Power Products, [by] maybe even a lower factor. So lower the adjustments we make on the volumes we get from our customers, because across the board, we are seeing lower volumes. The factory that is geared for a given volume, it doesn't take too much of a downturn to affect your income.

Of course, and --

We're certainly taking a look at that.

You talked a fair amount about the development costs for General Motors, which makes obvious sense. I think you mentioned the Ford D program or something. Is that another -- is that a new development program? So some of the cost maybe from the GM will roll into that, the development costs?

No, that's we are fully launched on the two Ford platforms, D car and U car. We originally launched purchasing the [painted bezel] from a supplier. We had tremendous amount of issues with that supplier, incurred a lot of the premium freight, overtime in our plants. We've talked about that for -- on several calls now. We chose to bring that manufacturing process in-house. We are probably about 80% complete doing that. However, Ford's volume is up, and so we've not been able to move away from the vendor completely, and that of course impacts our prime costs.

Okay. When -- is there an anticipated time when that vendor will be gone?

We are anticipating in probably in the next 12 weeks or so in this quarter we should be -- have that behind us.

Okay, good. So that will help the margins a bit then.

Yes.

Okay. All right. Thank you very much.

Thank you.

(Operator Instructions)

It appears we have reached the end of our question-and-answer session. I will turn the call back over to management.

Thank you, Kevin. We will wish everyone a very safe and pleasant holiday season and say good morning. Thanks a lot.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.