Methode Electronics Inc (MEI) 2015 Q2 法說會逐字稿

Welcome to the Methode Electronics FY15 second-quarter earnings conference call.

(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 performance 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 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 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; investment in programs prior to the recognition of revenue, timing, volume, quality, and cost of new program launches; ability to withstand price pressure; dependence on our supply chain; dependence on the availability and price of raw materials; customary risks related to conducting global operations; currency fluctuations; income tax rate fluctuations; fluctuations in our gross margins; the recognition of goodwill impairment charges; ability to keep pace with rapid technological changes; location of a significant amount of cash outside of the US; ability to successfully benefit from acquisitions and divestitures; ability to avoid design or manufacturing defects; ability to protect our intellectual property; ability to compete effectively; ability to withstand business interruptions; a breach of our information technology systems; and costs and expenses due to regulations regarding conflict minerals.

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

Thank you, Adam, and good morning, everyone. Thank you for joining us today for our FY15 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.

As we reported this morning, year-over-year second-quarter sales grew 20%, and first-half sales grew 25% driven mainly by higher North American Automotive and Power Product sales, partially offset by decreased sales in Interface. Looking to the second half of the year, we expect revenues to decrease slightly compared to the first half, affected by the full impact of the contractual Automotive price reductions of the first portion of the Ford center console program going end-of-life in the fourth quarter, lower overall third quarter sales due to the holidays, and reduced appliance sales, which is I'll discuss further in a minute.

Second-quarter consolidated gross margins increased 450 basis points, and in the first six months, improved 370 basis points, driven mainly by higher sales and the corresponding manufacturing efficiencies. But margins were also positively impacted by a $1.3 million reimbursement for the cancellation of a sensor program worth $9 million in annual revenues, which was to start in FY16; $0.6 million for increased manufacturing efficiencies; non-recurring price increases on legacy products; and other improvements at AMD Methode's captive injection molder; also, a very favorable Automotive and Power Products sales mix; as well as increased volume at our lower cost manufacturing facility in Egypt. We want to take a moment here to congratulate our teams in Europe and Egypt for the successful start-up of this facility over the past few years.

Looking forward, we anticipate lower second half margins as a result of decreased overall third-quarter revenues due to the holidays; lower appliance sales; the absence of the cancelled program benefit; and one-time price increase we saw in the second quarter, the first portion of the Ford center program going end-of-life; the full impact of the truck and SUV contractual price reductions; and higher R&D spend for the chip development on the 10 gig transceivers of approximately $2 million.

Worldwide, we are very pleased with efficiencies, which all of our factories are operating at, and I congratulate our teams on their continuous efforts to improve manufacturing efficiencies. These efforts to continue to have a very favorable effect on our margins.

Year-over-year, second-quarter selling and administrative expenses as a percentage of revenues increased to 11.1% from 10.3%, and for the first six months, decreased slightly to 10.6% from 10.7%. In the second quarter, salary and bonus accruals increased due to the Company's strong performance. We do expect compensation expense to increase SG&A as a percentage of sales in the second half of the year as well.

Additionally, legal, travel and other expenses also increased. Legal expenses were $3.7 million in the first half and we anticipate approximately the same for the second half of the year. As such, we expect SG&A as a percentage of sales to approximate 11% for the full year.

Our second-quarter operating margin was 15.1% compared to 11.4% last year, as income from operations improved 60% to nearly $35 million. In the first half, operating margin increased to 14% from 10%, as income from operations grew 71% to $63 million.

Earnings per share improved 29% in the second quarter and 39% in the first half, despite the fact that, year-over-year, our effective tax rate increased from 6.6% to 25% in the second quarter, and from 7.5% to nearly 25% in the first six months.

Given these results, we have increased our overall profit outlook for FY15 to a range of $114 million to $120 million for income from operations and $2.20 to $2.30 for earnings per share. We are reaffirming our sales guidance range of $870 million to $885 million, as we anticipate appliance sales will be about $7 million lower in the first half due to our revised internal projections. Based on this guidance range, our FY15 operating margin target is in the 13.1% to 13.6% range.

Now turning to review of our individual segments. Compared to last year, Automotive segment net sales grew 32% in the second quarter and 40% in the first six months, due to overall higher center console sales, as well as higher lead frame sales, and non-recurring price adjustment at AMD.

Automotive gross margins improved to 25.9% in the second quarter and to 24.4% in the first half. As I mentioned a moment ago, higher sales were the main driver to the improvement, but margins were also positively impacted by a very favorable sales mix, vertical integration, the program cancellation reimbursement, increased manufacturing efficiencies, non-recurring price increases, and other improvements in AMD, as well as increased volumes at our low-cost manufacturing facility in Egypt. Without the reimbursement and price adjustment, first-half gross margins would have been 23.7%.

Looking to the second half, we anticipate Automotive gross margins will be lower compared to the first half, attributable to decreased overall third-quarter revenues to the holidays and the first portion of the Ford center console program that went end-of -life, and truck and SUV contractual price reductions. However, we still anticipate our Automotive gross margins will approximate the mid-point of our FY15 target range of low to mid 20%s.

During the second quarter, Methode was awarded the infotainment and HVAC modules, as well as other content for the next line-up of Aston Martin vehicles. The program is expected to launch in our FY17, with average annual revenue of $4 million per year for four years. We were also awarded a domestic center console program for an SUV for model year 2018, launching late in our FY17, with average annual revenue of approximately $18 million for four years.

Moving to Interface segment. Year-over-year, second-quarter revenues decreased 8%, driven mainly by lower North American remote control and appliance sales, and lower Asian remote control sales than last year. In the first half, sales fell 5%, due to lower North America appliance sales and lower remote control sales in Asia and Europe.

We anticipate Interface sales will be lower in the second half as compared to the first half, due to a reduced sales outlook for appliances. Sales to our largest appliance customer for a major laundry program dropped off significantly towards the end of the quarter. Therefore, we have reduced our expectations for the program for the balance of this year. Compared to FY14, Interface's gross margin declined in both periods, due to the lower sales.

In Power Products, year-over-year sales improved 15% in the second quarter and nearly 5% in the first half, driven mainly by higher North American and Asian datacom sales, as well as increased demand for busbars and cable assemblies in Asia, somewhat offset by lower bypass switch sales in Europe.

The segment is having its best year in its 30-year history. I congratulate the team on this very noteworthy accomplishment. Year-over-year, Power Product's gross margins improved to nearly 32% in the second quarter and 29% in the first half, due mainly to a favorable sales mix and manufacturing efficiencies.

Finally an update on Dabir. Over the last two months, 100-plus cardiovascular surgical procedures have been performed utilizing the Dabir Surface, with zero adverse tissue effects or quality issues. The surgical procedures were 4 to 8.5 hours in duration, with patient weights ranging from 150 to over 400 pounds. These procedures are taking place at one hospital in the Midwest, which is part of our safe launch strategy.

It is our intent to add additional surgical sites using Dabir services early next calendar year. We are currently negotiating a roll-out plan with two more hospitals in the Midwest and one in Asia. This process entails a great deal of documentation with the hospitals, as well as meeting the requirements of their respective internal review boards.

Our commercialization strategy continues to be the utilization of direct sales, independent sales representatives, and distributors. We are currently focusing on hiring representatives nationally who specialize in the surgical arena, and to date, we have secured positions in the Midwest and the Northeast.

In summary, Methode's first half revenue growth, combined with manufacturing efficiencies, vertical integration, and a favorable sales mix enable us to post strong margins and operating profit, as well improved earnings per share, and resulted in improved overall profit outlook for the fiscal year.

We look forward to pursuing the opportunities in front of us and continue to strive to grow our industrial and medical businesses through product development and innovation. Now, I'll turn the call over to Doug who will give us further details regarding our financial results.

Thanks, Don. Good morning, everyone. I have just a few brief comments on the quarter and the six-month period.

Again, the effective tax rate we used in our guidance is in the mid 20%s. Again, this is higher than the previous year because of the effect that we no longer have the net operating loss valuation allowance to shelter the book income. So for the six-month period, the tax rate which included some first quarter discrete items, was 24.9%. As we mentioned on the call last time, we still have tax net operating losses available, which we expect will keep US federal cash taxes and certain state cash taxes to a minimum throughout the fiscal year.

The shares used to calculate diluted EPS for the six-month period increased to 39 million from 38.6 million in the first quarter. This is due to the performance-based restricted stock awards that were issued back in 2011, which vest at the end of FY15. The accounting rules require that the shares be recognized in the shares outstanding calculation when the performance threshold is achieved, which again, occurred in the second quarter. So for the full year of 2015, the diluted shares outstanding will increase to approximately 39.5 million shares.

CapEx in the first half of FY15 was $10.8 million. For the full year, we expect it to be at the $22 million to $25 million range. That's the same as our prior estimate.

Depreciation and amortization expense for the first half of 2015 was $12 million, and again, we expect the full year to be at about the $24 million to $27 million range, which again, is unchanged from our prior estimate.

EBITDA in the six-month period was $75 million, or nearly 17% of sales. Based on our 2015 guidance range, we expect EBITDA to remain in the 16% to 17% range and be between $140 million and $145 million.

Free cash flow for the six-month period was $48.6 million, and again, based on our guidance we would expect the full-year free cash flow to be between $89 million and $93 million. Don, that concludes my remarks.

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

(Operator Instructions)

Our first question comes from the line of Jimmy Baker with B. Riley & Company. Please go ahead with your question.

Good morning. This is Austin Drake on for Jimmy Baker. Thanks for taking my questions.

Sure.

Can you provide some additional color on the cancelled Automotive program? What products were you supplying and what triggered the cancellation? Also, what was the annual revenue contribution and when was that expected to go end-of-life?

The annual revenue was about $9 million. End-of-life, probably three years. I can tell you it was not a torque sensor type product. I really don't want to get into anything more than it was a sensor. Negotiation with customers on cancelled programs can be a bit sensitive, but it was a sensor program slated for $9 million in our planning for next year. It was one segment of a worldwide program, one continent, that the customer decided to go a different direction with their product. It was nothing that we did. It was just a change in the customer's direction and we would expect to be reimbursed for our expenses.

Okay. Thanks. That's helpful. And then you experienced a large jump in SG&A deleveraging despite the 20% sales growth. How did that compare to your expectations and how should we think about SG&A going forward, not just this year, but in general, what kind of leverage would you like to see?

Going forward, we expected 11% for the balance of this year. SG&A, as I said in our prepared remarks, was affected by really compensation expense of -- because of Methode's performance. Going forward, and we're coming to the end of a five-year plan, we're having to accrue at the appropriate levels. That has an impact on SG&A.

That will not continue into next year as the plan terminates, and of course there will be another plan, but you start all over again. The [tandem] cash has an effect because of stock price, so some of that will mitigate next year, but every year we'll have salary increases, and so on, so we don't expect a meaningful increase in SG&A, but we do expect it to go up moderately as we go forward. Doug, I don't know if there's anything -- ?

A couple of the business units that were not performing up to the threshold a year ago started to hit their numbers, and so we needed to do basically almost a two-year catch-up on those accruals, because they are now performing either at target or at maximum, so there's quite a large adjustment for two of our business units in the one quarter.

Yes. Very good point.

Okay. Thank you and congrats on the quarter.

Thank you.

Thank you. Our next question comes from the line of Steve Dyer with Craig-Hallum. Please go ahead with your question.

Good morning, guys. How are you doing?

We are good.

Good. A lot of the implied weakness or the reason you are not raising more of the back half of the fiscal year comes from appliances. Did you lose a customer? It sounds like maybe your major customer pulled back quite a bit. Is that a function, do you think, of high finished goods or has their trajectory in that program changed at all?

The customer, we're on the front-load laundry program, which is a higher price point for the customer. The customer launched a top-load product, which may have eroded the front-load sales a bit. We don't know if that's all of it. We don't know if our customer's overall sales were down. The top-load is a lower price point to the consumer, so that could be the sum of it.

There is some expectations that might recover after the first of the year, but our experience has been that if there's a bit of a downturn, it lasts more than a few weeks so we, very wisely, reduced our forecast. So to some degree, Steve, it's too soon to tell. The product didn't go end-of-life. There's no recall. There's just us looking at our forecasting and releases from the customer and making adjustments. It occurred late in our second quarter.

Okay. Hopping over to Automotive, how long -- refresh my memory if you could, how long the K2 award is expected to run and maybe your understanding of when the successor to that program will go into bid?

Sure. It was a five-year program. We are in the second year, so we'll have another three years, three model years. When it gets rebid, I would say in the next 12 to 18 months, as it's really dependent on where the customer is on their design cycles, when they are out of the studio, or I'm not sure they are ever out of the studio, but where they're at the point they can request information and quotations from vendors, but I would expect, if it follows the same pattern as it did in the past, within the next 12 to 18 months.

Okay, and I'm guessing you're going to pass on this question, Don, but I'll ask it anyway. You guys have launched that seemingly pretty flawlessly. Any sense on confidence level for the next generation of that program?

(Laughter) Certainly a successful launch gets you a ticket to the -- or I shouldn't assume, but gets us a ticket to the next game, but it really comes down to design, our competitiveness, and so on. I probably already said more than our Detroit guys would like me to say, so I'll pass on that.

So you won't know for a while is the bottom line?

Correct.

Okay. And then lastly, as it relates to the Dabir product, can you remind me as to whether these are paid trials or not, and then any way of sizing up how you think about revenue in the out year for that product?

The trials are paid for. Generally, we will give the hospital the first month's expenses, not charge them for that just so they can try it and get comfortable with the product, but then after that, we expect to be compensated. We sell the overlays and then we lease or rent the controllers. Revenue-wise, as we get closer to giving our FY16 guidance, we'll put some parameters around what we expect. A little too soon to tell you.

We are encouraged by the number of surgeries, without a pressure ulcer, but I would say that's somewhat statistically inconsequential right now. We would want to see many, many more and at different hospitals before we could draw some conclusions, so it's just too soon to tell what the revenue numbers around it. We've had no issues with the launch. We've had no issues during the surgeries, so we're encouraged by that. Our production is set. We're hiring reps so we're definitely into the selling mode right now.

Great. Then one more quick one, if I may. Obviously, you continue to generate a lot of cash and the balance sheet is in great shape. Any more updated thoughts there, whether it be M&A or how you would look to deploy that?

First of all, a lot of our cash is still outside the US, which would -- if we did a European or an Asian acquisition, that would be helpful. We would pay, of course, taxes. We would repatriate it to the US. So as far as some of the other use of cash, other than acquisition, we're always saying, investing in our businesses and acquisitions are our number one use.

But as far as dividend increases or stock buybacks and so on, that is something we do discuss, and we'll probably get more discussion as we build our US cash position, but we are not quite there yet. And we did hire a New York boutique firm to assist us with acquisitions. They've been on board now for maybe three months and we've been meeting with them regularly to pursue acquisitions.

Got it. Okay. I'll hop back in the queue. Thank you.

All right, Steve, thank you.

Thank you. Our next question comes from the line of Christopher Van Horn with FBR Capital Markets. Please go ahead with your question.

Good morning. Thanks for taking my questions.

Good morning.

Just to your last comment there, are there any discussions about potential divestitures with the firm that you've hired?

We -- I won't say routinely, but, as really part of our annual review, we look at our portfolio of companies. Their review is to look at companies for acquisition, likely to be a larger dollar acquisition than we've done in the past, and so as I've said before, once you [were] to take on debt, then logically, you might look at some of our holdings that are not as core to our overall strategy, and then they would be part of that divestiture, if we chose to do that.

Got it. Thanks. Okay. Then you talked a lot about the lead frame, the transition lead frame, having some success this quarter. Was that specific to certain programs or was it a broad-based success? Can you just get into a little more detail there?

Sure, that is -- we're Tier 2 to Continental for a transmission controller. The revenues for that product do vary from quarter-to-quarter based on their customer demands. We don't get quite as much visibility there as we would if we were in Tier 1. That was a -- it had a very good quarter both in the -- we manufacture that in Shanghai and in Monterrey, Mexico. That, to some degree, maybe not -- more than to some degree, it goes with the [SAR], increased Automotive sales are very beneficial to that business, as it goes on several platforms.

Okay. Then when you talk about increased production out of the Egyptian plant, is there more to go? Is there more capacity in that plant than we might see in the coming quarters that will possibly help out margins here?

Yes, I would say in my margin comments, halfway from the mid-point of our target range, take that into account. But certainly as we enter 2016 and 2017, that is a key component of our strategy in Europe, and, of course, to improve our margins. For example, we're launching the Renault center console there, including the decorative painting, which is always difficult to launch.

That will give us a very strong positioning in Europe, from a cost standpoint, to pursue other center consoles and the other product. The team has done a very good job of bringing that factory up. It has definitely, this quarter, had a significant contribution. So I don't know that I would go any further on the second half of this year on margin improvement with that, but certainly going forward, it's a key factor.

Got it. Then one last question, if you don't mind. Could you just give us an update on the torque sensor pipeline?

We continue to receive favorable comments from our customers on the data that they are receiving from the torque sensor. There's been no, knock on wood, there's been no hiccups in the recent testing, and I feel that we'll know in this coming calendar year whether that is going to go on an automobile or not.

Great, great. Thanks and great quarter.

Thank you very much.

(Operator Instructions)

Our next question comes from the line of David Leiker with Robert W. Baird. Please go ahead with your question.

Hi, good morning. This is Joe Vruwink on the line for David.

Hi, Joe.

Don, you talked about a lot of things on why Automotive margins would have improved in the quarter, but if I just look at the sequential revenue increases you've seen really over the last 18 months, it would seem like this quarter stands out. Just thinking about gross profit contribution, it's been in the 20% range this quarter; even if you strip out the one-timers, it was 65%. Is there anything unusual that's going on there because it just seems like a very big jump?

You do need to take out the one-time. You said you did, but our factories continue to perform with excellent efficiency, low cost-to-quality, around the world. There's always room for improvement, but I don't know that I would take that and continue that into the next six quarters, this year and next year. We had a very favorable mix. I did point that out, and that will vary from quarter to quarter.

We have very good sales in Asia. Some of our domestic programs are certainly good programs for us, but some of our other programs, particularly outside the US, in Europe and Asia, carry higher margins. When that mix flows in the right direction, that has a very positive effect on margins. Some of the programs that we have in Asia are much smaller than our US programs, but they do carry higher margins.

I don't want to raise expectations, but that's something that we can continue through the next 12 to 18 months, [if] we do have price reductions that are contractual, that those do go into effect automatically. We try to offset those with our factory efficiency and changes and so on, but they have an effect. Doug, I don't know if there's anything else you'd add?

No, I don't think I can.

I mentioned on the last question, Egypt has been a positive factory. We've seen that, but that's not a step function that will improve as time goes on, but then there's also going to be offset by price reductions elsewhere in the world.

Okay. Switching gears a little bit, you touched on the Ford center console rollout. Is there any way to frame the dollar impact initially and the time frame, over what time those seven vehicle models will be rolling off?

It's up to the customers as to when they actually introduce those, but in round numbers -- and this will vary by the customers' production needs quarter-to-quarter -- but in FY14, last year, the business was in the high $40 million range continually. We saw that in Q1 and Q2 this year as well. Q3 and Q4 are going down to, let's say, $15 million, $16 million, $17 million range, and then next year total is around $12 million. Again, those will vary by the customer demands.

Okay, that's helpful. Then last one from me is, first of all, congrats on the center console award, I'll look for Methode in the next James Bond film (laughter). On the domestic programs you've won, there's three now that are launching domestically in that FY17 time frame. Just wondering, are you utilizing your own touchscreen on any of those and can you say if the -- I know you can't announce OEMs -- but can you say whether those programs are with different domestic auto makers?

It's one of the Detroit Three. We are using our -- I want to verify it, but I believe we are using our capacitive touchscreen on the majority, but I think I want to get back to you on that. There may be one with a smaller non-touchscreen.

Okay. Are they all three with one of the Detroit auto makers, or do you have several of them represented?

I'll pass on that question. I just -- we can announce what customer and program once our customer does, and they haven't done that, so I need to pass on that, Joe.

Okay. Fair enough. Thank you, guys.

Thank you, Joe.

Thank you. Our next question comes from the line of Steve Dyer with Craig-Hallum. Please go ahead with your follow-up.

Thanks. Just a follow-up for me, guys. As it relates to the capacitive touchscreen, have you changed over to that on the K2 program yet?

We can say that we are totally vertically integrated on that.

You are. Okay. What about the [31 XX]?

Yes. We're totally integrated on all of that.

And does that offer margin upside going forward? I know you had high expectations for a margin bump there or have we already begun to see that, or what would you -- ?

It's hard to quantify. The factory efficiencies and the overall, as I stated earlier, the overall performance of the factories is probably the main driver here. Some of the vertical integration certainly plays into that, but overall, I would say that we've seen the benefit of all of those efforts, and, yes, the factories can continue to improve, and they should.

But we've seen -- I believe we've seen the benefit of all of that. Those were all designed to, of course, improve margins, but also provide the contractual price down to our customers. So as I said, good job to the teams and good planning, particularly, because the planning for those events started two years ago, more than two years ago.

Okay, thank you.

Thank you.

Thank you, ladies and gentlemen. There are no further questions at this time. I would like to turn the floor back over to Management for closing remarks.

Adam, thank you very much. We'll close out the call by wishing everyone a very safe and pleasant holiday season. Good day.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.