Methode Electronics Inc (MEI) 2014 Q2 法說會逐字稿

Welcome to the Methode Electronics fiscal 2014 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. 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 of the date hereof. These forward-looking statements are subject to 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 these actual results to differ materially from our expectations are detailed in Methode's filings with the Securities and Exchange Commission, such as our Annual and Quarterly Reports.

Such factors may include without limitation the following: dependence on a small number of large customers including two large automotive customers; dependence on the automotive, appliance, computer, and communications industries; customary risks related to conducting global operations; timing, quality, and cost of the new program launches; ability to avoid design or manufacturing defects; ability to compete effectively; dependence on the availability and price of raw materials; dependence on our supply chain; further downturns in the automotive industry or the bankruptcy of certain automotive customers; the ability to keep pace with rapid technological changes; ability to protect our intellectual property; ability to withstand price pressure; location of a significant amount of cash outside of the US; the recognition of goodwill impairment and long-lived asset charges; currency fluctuations; ability to successfully benefit from acquisitions and divestitures; ability to withstand business interruptions; income tax fluctuations; a breach of our information technology systems; and the cost and implementation of SEC disclosure and reporting requirements regarding conflict minerals.

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

Thank you, Jessie, and good morning everyone. Thank you for joining us today for our fiscal 2014 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.

We were very pleased to report this morning that second-quarter sales grew 47% to $190.9 million, and six-month sales grew 44% to $358.2 million. Second quarter and first-half sales came in higher than we expected, due mainly to strong sales for the General Motors center console programs as well as new product launches in our European automotive and North American power products operations, along with strong appliance sales.

As a reminder in the second quarter of last year we recorded a $20 million litigation settlement which substantially benefited our profitability last year. Excluding the impact of that settlement and its effect on income tax expense, second-quarter net income grew nearly fourfold to $19.8 million or $0.51 per share.

For the first half net income also grew nearly fourfold to $33.4 million or $0.87 per share, again excluding the settlement. While higher sales were the largest driver to the year-over-year improvement in both periods, increased manufacturing efficiencies due to the vertical integration of the paint and laser etch process, favorable raw material pricing, and a favorable product mix in the power products segment, and lower income taxes also contributed to the remarkable growth in earnings.

Second quarter and first-half net income was negatively impacted by increased marketing, travel, and legal expenses compared to last year as well as the absence of a customer bankruptcy accrual reversal in the year ago quarter.

Additionally, we incurred increased compensation expense of $2.7 million during the second quarter and $4.4 million in the first six months related to our long-term incentive program. The long-term incentive awards, which are based on the Company's performance in fiscal 2015, will become payable if performance under the plan meets or exceeds targeted performance. This adjustment reflects the Company's estimates of fiscal 2015 performance.

Second quarter consolidated gross margins improved to 21.7% compared to 17.2% last year. For the six months, consolidated gross margins improved to 21% from 17.6% in the same period of fiscal 2013. Again the largest contributor to the improvement in margin was increased sales.

But margins were also positively impacted by the vertical integration, favorable raw material pricing, and sales mix and the power products segment, as well as lower scrap on the Ford center console and General Motors K2 programs. However, gross margins were negatively impacted by increased sales of products with a higher material content in the interconnect segment.

Also of note, consolidated SG&A as a percentage of revenues decreased to 10.3% from 11.7% in last year's second quarter, and for the first half dropped to 10.8% from 13.1% in fiscal 2013. We are pleased with the considerable leverage realized given our substantial rise in sales.

As we announced this morning we have increased fiscal 2014 guidance, and now anticipating sales in the range of $720 million to $750 million, and earnings per share in the range of $1.70 to $1.90. This replaces our previous guidance of $670 million to $700 million in sales and $1.40 to $1.60 in EPS.

This increase in sales and earnings is based on higher second-quarter sales and earnings than we originally anticipated, stronger than originally projected fiscal 2014 sales for the General Motors K2 program, offset by anticipated softer second-half European sales. The low end guidance reflects our concern regarding stabilization in the European economy as well as potential softening in our interconnect and power product segments over those achieved in the first half and possible production delays of new products.

The high end of the range anticipates stabilization in Europe and higher domestic automotive revenues. And as I mentioned on last quarter's conference call, current releases are indicating that second-half European sales will be below the first half.

Based on the new guidance ranges, our fiscal 2014 operating margin target increases to an approximate range of 9.5% to 10.5% from the 9% to 10% we discussed last quarter.

Now, turning to a review of our individual segments, compared to last year automotive segment net sales increased 57% in the second quarter and nearly 52% in the first half due mainly to production of the General Motors K2 program. Additionally, new program launches in Europe and higher sales in Asia also contributed to the revenue growth.

The second quarter of improvement was partially offset by lower sales of the Ford center console program year over year. At this point we anticipate sales of the Ford center console program in the second half of this year to be approximately 10% lower than the first half, which we have taken into consideration in our updated guidance.

Second quarter automotive gross margins improved to 19.7% from 14.8% last year and first-half gross margins increased to 18.9% from 14.1% year-over-year. In both periods, increased manufacturing efficiencies driven by higher sales and the benefit of the vertical integration produced improved margins. Based on anticipated sales in the segment, we believe fiscal 2014 automotive gross margins will vary quarter to quarter, but will likely be in the 19% range.

I am also very pleased to announce that during the second quarter Methode was awarded a new integrated center console program for a North American OEM with final product delivery to South America and Asia. Production is slated to begin in our fiscal 2017, with annual revenue in the $15 million range. This award continues to show our capability and expertise in the center stack space.

Moving to interconnect, sales increased nearly 31% in the second quarter and over 34% in the first six months compared to last year, attributable mainly to improved appliance sales from our two largest customers. Volumes for the new laundry program came in near our expectations. Radio remote control sales were flat in both the second quarter and first half year-over-year.

Compared to last year interconnects gross margins improved slightly to 25.7% from 25.5% in the second quarter due to manufacturing efficiencies, but fell slightly in the first half to 26.2% from 27.5%. Increased laundry sales, which have a higher material content than other products in the segment, have the biggest impact on margins. For margins to improve in the segment we would need to improve sales in Etronics European industrial business.

Additionally, we substantially leveraged selling and administrative costs which contributed to a 68% increase in interconnects income from operations in the second quarter and a 57% improvement in the first six months.

Moving to power products, year-over-year sales improved nearly 50% in the second quarter and almost 47% in the first half. The launch of a significant program for a datacom customer in the US, along with bus bars for the Nissan Leaf battery pack and a high current bypass switch, both in Europe, drove the growth over the last year. While we have limited visibility, we do anticipate this run rate will continue at least through the third quarter of fiscal 2014.

Power products gross margins increased in the second quarter to 26.2% from 12% last year, and in the first half to 24.1% from 14.2% year-over-year. The improvement was driven by a favorable product mix as well as lower raw material and lower new product development costs. We anticipate the segment will meet its margin target for the fiscal year.

Before turning the call over to Doug, I would like to briefly discuss the updated revenue chart we posted on our web site and filed as a Form 8-K this morning. The sales projections are as of today for fiscal years 2014 through 2017. As new business opportunities are awarded, we will, as we have in the past, announce significant awards on our quarterly conference calls.

On the revenue chart, the opportunities in fiscals 2016 and 2017 include pending automotive wins, sales from new products, and current opportunities in non-automotive businesses. Of note, Methode's compounded annual growth rate from fiscal 2013 to fiscal 2017 is approximately 16%, based on these projections.

Now I will turn the call over to Doug, who will confer the details regarding our financial results.

Thank you, Don. Good morning, everyone. I have just a few brief comments on the quarter.

In the second quarter in SG&A, as Don mentioned, the long-term incentive expense -- the expense for the tandem cash awards was $1.7 million. This expense primarily reflects the increase in our share price during the second quarter, and that will continue as the stock fluctuates until the end of our fiscal 2015.

For the first six months we spent $16.5 million for capital expenditures. For the full year we continue to expect capital spending to be between $25 million and $30 million. This includes the additional capital needed to launch the SUV portion of the K2 program.

Depreciation and amortization expense for the six-month period was $11.5 million. For the fiscal year we expect full year depreciation and amortization to be between $23 million and $25 million.

For the full year the effective tax rate is $7.6 million. This is lower than our previous estimates, due to primarily to increased domestic income which is sheltered by net operating loss carry-forwards. The effective tax rate does not include any adjustments to valuation allowances which may result from charges -- changes in events and circumstances.

Looking at free cash flow for the full year, given our guidance that we put out this morning we would expect that to be between $65 million and $75 million. Don, that's all I have.

Thank you very much. Jessie, we are ready to take questions.

Thank you. Ladies and gentlemen, we will now be conducting our question-and-answer session. (Operator Instructions). David Leiker, Robert W. Baird.

Hi, good morning, guys. This is Joe on the line for David. Just on the updated revenue targets today and the pathway to $925 million down the road, can you maybe talk more about what meaningful products contribute to reaching that target? Are there technologies or product lines that are maybe smaller today but could be more meaningful 3 to 4 years from now, thinking along the same veins of what the center console business has done?

Sure. First off we continue to book for 2016 and 2017 automotive products, although 2016 will be tapering off here very shortly. I can tell you that we are in negotiations for probably $14 million or $15 million of business for 2016 that contributes to that $77 million that we were showing. And that's hitting switches and various products of ignition switches and so on, various products like that.

Then in 2017 we continue to book center console business that we announced a little bit ago. And then on top of that, as we detailed in your conference a month or so ago, transmission lead frames which we have today and have business with, we will continue to book that.

10 GB transceivers for a datacom -- that would be a new product, that will be introduced next year. We talked about that in our presentation. I think that presentation is on our website. New power products -- those have not launched. Those will be introduced at a tradeshow early next year for datacom customers.

Then to the last part of your question, the Dabir Therapeutic Support, which I think we have two pages of information on that on the presentation -- that will launch next year. And that could certainly be a major contributor along the lines of center stacks.

Do you think that could be on the same magnitude as center consoles?

If you do the research on pressure ulcers, there's a very, very large market. Yes, that does have that potential. But we've not lot launched the product yet, so I'm not willing to say exactly what, but if you do the math it's a very large opportunity.

Okay, interesting. Maybe just looking at the free cash this year, $65 million to $75 million. It seems like you're just scratching the surface of opportunities in the datacom markets. Would you maybe consider an acquisition to grow further? Or do you think the things you have in-house in the portfolio right now are enough to grow quite profitably?

Well, acquisitions clearly are a part of our strategy. We would certainly consider that. We've commented before that we look for tuck-in acquisitions, as well as major acquisitions. So, something that would further the technology or path to market in data would be a welcome opportunity for us.

And then maybe shifting over to the margin side, right now your earnings are running at basically $2 annualized. And thinking about the margin targets, the automotive business is basically running at your fiscal 2015 gross margin targets. So would it be fair to say that you have been executing above the original plan and maybe some of these margin targets move higher, so automotive is now a 25%, a mid-20% gross margin type business?

No. I don't think I would go that far. There's a lot pressures in automotive. I think we will stick with our target of low 20s.

We are -- came out of the box better than we thought, because really our lower scrap vertical integration went very well. But I don't know how much more above that we are going to get, so I think we will stick with where we are there.

And then my last one -- if I just look at SG&A and strip out the incentive comp programs, it basically looks like you're still running at 2008 to 2011 levels, but your revenues are about two-thirds higher than that time period. So is this level sustainable or would you expect maybe a slower slow creep?

Well, SG&A absolute dollars will grow. But we would expect to continue to get the leverage from a percentage standpoint. Back in 2008 and 2009, we said we purposely maintained a very high SG&A level while we sought new business and then launched that new business. So, going forward we should continue to get the leverage from that. That's an integral part of our business plan going forward.

Great. I'll leave it there. Congrats on the nice quarter.

Steve Dyer, Craig-Hallum.

Gentlemen, congratulations on the continued stellar results; very nice. A couple questions -- have you begun shipping the SUV portion of the GM program yet?

I can't answer that.

I'm asking in a way that -- I'm trying to ask in a delicate way. Would you anticipate that you will have shipped in this quarter?

Let me answer it this way. We have performed our run at rate for our customer and passed with flying colors, so that is the final step towards production and we are filling our pipeline now.

Okay. Fair enough. Thank you. I noticed earlier this week the new Honda Civic is shipping with a capacitive touchscreen which strikes me as a little bit surprising, given that the price point and so forth of that vehicle. Are you seeing more opportunities sort of downstream on the capacitive touchscreen front?

Yes, we are. Yes, because it is just a desirable feature in a vehicle and it provides for more responsive touch for the customer. And it's not necessarily an easy changeover, but it can be accomplished without having to redo your whole center console.

Sure. Okay. And then I noticed on the torque sensor business, you exclude that here from your revenue waterfall. Is there any particular reason for that? Do you feel sort of less bullish than you have, or you just don't have any wins yet, or how do you think about that?

No, not at all. We are still very bullish on the technology. But we had said in the past we thought that those wins or revenues would come in the fiscal 2018 timeframe, so we would be a year out from 2017 or from the chart just published. But no, we are still pursuing business there and providing funded prototypes to customers.

Sure. Okay. Speaking of that chart, I know one of the pluses and the minuses, I guess both, is that you have great visibility but there's not a lot of opportunity to influence that necessarily one way or the other. But I noticed that fiscal 2015 has increased from $720 million the last time you showed that chart to $800 million now. What accounts for that, given that it's obviously not necessarily new revenue for new wins, per se?

We have more visibility into K2 and SUV [31X]. So that adjustment was made. Our power products have new products that have been successful, laundry programs. So it's just -- we got another year's closer to 2015 and adjusted the numbers accordingly. I think we pointed out in the chart that we use LMC Automotive data for our forecast.

Yes. Okay. Makes sense. And then last question just going back to the center console, I'm assuming you feel like you have enough sort of engineering time now that the K2 pig is moving through the python, so to speak, that you're aggressively bidding out sizable programs kind of in that 2016, 2017, 2018 timeframe?

That's one of the things we point out to our customers on a regular basis. And we've got several successful launches behind us, and we have the engineering prowess and the capability to launch more programs for them.

Sure, okay. And I guess one quick last one -- cash flow, as was mentioned, is starting to build pretty nicely. The balance sheet going to be -- already is impressive, but is only going to get better. Other than acquisitions, any thoughts for management of that?

We continue to invest in our business. We've detailed in our recent presentation some of the technologies we are working on.

First and foremost we will support our new business ventures with capital as needed. We will continue to have a dividend. We take that one quarter at a time, but we've paid one for 35 years.

And acquisitions are key to us. You talk about 2015, we want to have a meaningful impact in 2015, do an acquisition -- even if it's a tuck-in acquisition that would be -- certainly support our growth in 2015 beyond what we will get from our current wins.

Sure. Okay. I'll hop back in the queue. Congrats, again, guys.

Jimmy Baker, B. Riley.

Hi. Thanks. Good morning. Congratulations on the progress and another great quarter.

So, Don, just to follow-up on the margin questions earlier, I think your most recent presentation it stated a 10% to 11% operating margin target for fiscal 2015. But as you have mentioned today, the new fiscal 2014 guidance suggests at least the low end of that target is likely in play here in fiscal 2014.

I guess in light of that how would you are update your operating margin target for 2015? And then even looking out a couple years, do you think you'd be running at a maybe a mid-teens operating margin as you work towards to gross margin goals on higher volume? What kind of leverage are you expecting?

Let me answer the first -- or the second half of your question first. The new products that we've introduced or will be introducing are all geared to improving our margins. We have said publicly we target a 1% margin increase per year.

We feel we would be doing well if we could do that. I think that still holds. I think we want to see how in the later years of 2016 and 2017 we want to see how these new products go, and what kind of margins we get from that.

As to next year, I think I'll stick to my comment that 1% year-over-year increase is something we've targeted. And we will take a look at that as we get closer to 2015 and the guidance. I'm just very pleased that the number of initiatives we've put into place -- aside from the sales increase -- but the number of initiatives we put in place in our factories and our business units are allowing us to get close to what we set for next year.

Okay. That's helpful. And then, if I remember correctly, I think on the last conference call when we were about a third of the way through the second quarter, you were looking for Q2 sales to be roughly flat sequentially. And yet you ended up posting a 14% quarter over quarter gain.

I'm just trying to understand the drivers of the variance, because it seems like the strength came from automotive, where you could typically have pretty good visibility nine weeks forward. Were you just not trusting the releases you were seeing at the time? Or were you maybe -- in other words, were you maybe overly conservative in discounting those? Or did you see a real strong push late in the quarter from your customers? Just trying to understand the variance from the last guide.

Let's talk about sales first. Auto sales -- worldwide auto sales were higher than we forecasted it when we provided the guidance. I think that we are in, to some degree, uncharted territory on K2. We can't look back a year ago and look at sales. That's a key contributor to our forecast.

At the time we looked at what releases we had, what information we had, and we roll up a worldwide forecast and that's what we based our guidance on. If I look at the non-automotive, electronic, touch sensor, power products, they were all pretty much where we anticipated them to be. It was the worldwide auto sales that came in higher than what we had forecasted.

And then earnings and margin really just falls through from the auto sales. Our factory efficiencies were slightly better than we anticipated; favorable commodity prices. We also had lower taxes, too.

That's helpful. Just digging into the K2 a little bit further, and I think you alluded to this on the response to why the favorable revision to 2015 revenue -- I think heading into fiscal 2014 you were looking for $139 million in sales this fiscal year from that program, including $29 million for the SUV. And then you saw that ramping to $216 million by fiscal 2016. Can you update those projections given what we've experienced so far and what the updated volume projections are for the program?

At this point we direct you to the published data on GM, LMC, and others. I can't -- because we are in production, I really can't comment on what our customer releases are.

But I can tell you that we've taken that into account in our increased guidance and our projections for 2015 and beyond. 2015 and beyond is based on LMC data. The $139 million -- that would obviously increase if we were to redo that number, but again, since we are in production now I would refer to the large amount of data that's put out on GM.

Okay. And if I can just maybe give Doug a chance to speak here, can you just maybe give us a view on how the tax rate will evolve over the next -- well, not just through the balance of this year, but over the next couple years and the cash tax variance as your profitability mix shifts by geography?

And then also, what's the share count assumption for this year's guidance -- just a housekeeping item?

Sure. The share count guidance I think is [38.4] is what we are using currently, Jimmy. On the tax side, our tax rate currently is about 7.6%, the effective tax rate, which is lower than we had last quarter. Again, that's driven by the upside in domestic revenue, domestic earnings.

We are still benefiting from the net operating loss carryforward in the US. What will happen eventually when the NOL is consumed, we expect the tax rate to jump up probably to around a 20% tax rate.

And in our Q we added some additional disclosure about the fact that we don't have the luxury of just letting the NOL up be consumed until it's expired. But the accounting rules will require us to pick up a tax benefit when we get to the point where we can fully -- we feel very comfortable that we will benefit from the utilization of the NOL.

So, what will happen is that will be an event that happens in some future quarter for us. But I think going forward with life after the NOL, we're looking at about a 20% tax rate.

Okay. Great. Thanks very much for the time. I'll take the rest of mine off-line.

Nathan Jones, Emerald Advisers.

Hi, guys. Congratulations on a great quarter. So I was just curious -- it seemed that there was some anticipation that the actual production issues for the K2XX platform was going to have somewhat of a negative impact on your results this quarter. Can you kind of just talk about why that didn't seem to impact you in anyway?

Are you referring to the American Axle?

Yes.

I don't know how to -- I don't want to speak for American Axle and I certainly don't want speak for GM.

I guess a better way to phrase that is it seemed that there were downward revisions across the board on what the production look like coming in through October. So I guess you would've expected that that would have been impacted the guidance that you had planned for.

You know, we ship what the customer releases to us, and we had a range -- and actually we ended up outside that range on the high end. I'm trying to answer your question but it's difficult. We are in -- as I said to Jimmy -- we are in uncharted territory. I can't look back year -- (multiple speakers)

Okay. So is mostly because you didn't have anything to go off of from a year ago?

That's correct.

Okay.

Okay. Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Duda for any concluding comments.

Jessie, thank you very much. We will thank everyone for listening and wish everybody a safe and pleasant holiday season. Good day.

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