Methode Electronics Inc (MEI) 2016 Q1 法說會逐字稿

Welcome to Methode Electronics FY16 first-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 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.

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 communication industries, and [thus the end] programs prior to the recognition of revenue, timing, quality, and cost of new program launches; ability to withstand price pressure, including price concession; 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 the United States; ability to successfully benefit from acquisitions; divestitures; ability to avoid design or manufacture 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 [complex] materials.

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

Thank you, and good morning, everyone. Thank you for joining us today for our FY16 first quarter financial results conference call. I'm joined today by Doug Koman, our Chief Financial Officer; and Ron Tsoumas, our Controller and Treasurer. Both Doug and I have comments, and afterwards we will be pleased to take your questions.

As reported this morning, Methode was awarded a contract from a major North American OEM who currently constitutes a substantial portion of the Company's annual automotive revenue. This award is for the next generation of an existing program with this customer. When we are able to, we will provide more details on this program.

Additionally, the Board of Directors has authorized the repurchase of up to $100 million of Methode's outstanding common stock over the next two years. We are pleased to be in a position to consider stock repurchases, given our long-term outlook for growth, strong balance sheet, and cash generation.

Moving on to financial results, FY16 first-quarter sales decreased 6.8%, driven mainly by lower interface sales, and the effect of currency translation, partially offset by slightly higher automotive and power product sales. However, net income improved nearly 10%, driven by consolidated gross margin growth of 320 basis points, positively impacted by favorable currency translation on raw materials and labor costs, favorable commodity pricing of raw materials, a refund of import duties from prior periods, and manufacturing efficiencies due to increased automotive production at the Company's lower-cost manufacturing facility in Egypt. Partially offsetting these favorable factors were costs and inefficiencies in our interface segment, due to transfer manufacturing from the Philippines to Egypt.

Year over year, first-quarter selling and administrative expenses as a percentage of revenues increased to 11.4% from 10.2%, due mainly to lower sales, along with higher legal, professional services, and travel expenses, partially offset by lower stock-award compensation expense. First-quarter operating margin was 15%, compared to 13% last year.

As I noted earlier in our release this morning, we are expecting our power segment to approach break-even in the second quarter, which would likely lower Methode's second quarter net income below the first quarter. However, in the second half of the year we are anticipating that an increase in income from our European operation should offset the deterioration from the power segment. As such, we are reiterating our FY16 guidance for sales in the range of $830 million to $865 million; income from operations in a range of $108 million to $119 million; and earnings per share in the range of $2.07 to $2.22. Based on this guidance range, our FY16 operating margin target is in the 13% to 13.8% range. These guidance ranges are based upon Management's expectations as of this date, and involve a number of risks and uncertainties, as detailed in our release.

Now turning to a review of our individual segments. Compared to last year, automotive segment sales declined nominally in the first quarter, as the result of lower volume in the Ford center console program, lower steering angle sensor product volumes, as well as pricing concessions. These negatives were partially offset by higher General Motors center console and transmission lead frame assembly product volumes, improved tooling sales, and increased hidden switch product volume in our European operations, as well as higher linear position in interior lighting product lines in our Asian operation. Automotive gross margins improved to 28.4% from 22.3% due to favorable currency impact on raw materials and labor costs, favorable commodity pricing of raw materials, a refund of import duties for prior periods as well as increased production at the company's lower cost manufacturing facility in Egypt, partially offset by pricing concessions. For FY16, we are still targeting automotive gross margins in the mid-20% range.

Moving to our interface segment, first-quarter sales decreased 23.4% year over year, attributable mainly to lower appliance and data solution product volumes; however North American and European radio remote control volumes improved slightly in the first quarter. Compared to last year, interface gross margins declined to 21.4% from 27.5% in the first quarter, due to lower sales and costs associated with the transfer of manufacturing. We believe this move will reduce our manufacturing costs going forward for the interface segment. Without the costs associated with the relocation of manufacturing, interface's first quarter gross margins would have been 24.3%. For FY16, we are targeting interface gross margins in the range of 23% to 25%.

Moving to power products, net sales increased about 2% over last year, attributable mainly to higher bypass switch and bus bar product volumes in our European operations, and higher sales of bus bar and cable products in Asia. However, this was offset by a decline in North American sales, mainly as a result of lower sales to our big data customer. Looking forward, we are anticipating revenue in this segment, which is typically one of our highest-margin businesses, will be considerably lower than we originally expected for the remainder of this fiscal year, with income approaching break-even in the second quarter. We have not lost business, just seeing reduced demand almost across the board from customers such as Cisco, Juniper, ABB, Rockwell, Mitsubishi, AMD, and Schneider. Segment gross margins decreased to 24.8%, from 25.9% year over year, due to manufacturing inefficiencies in North America as a result of lower sales. Based on the lower anticipated revenues for the segment, we have reduced our FY16 target gross margin percentage for the power product segment to the [low] 20%s.

Now an update on our new business awards. In automotive, in Europe we were awarded an HVAC control unit for Renault passenger cars. The program is scheduled to launch in our FY18, with the initial revenue of approximately $2 million ramping to about $20 million in FY19. This is a 10-year program. The HVAC, or electronic climate control module, is a smaller version of the integrated center panel for Renault's Global B platform, used where the climate control functions are separated from the infotainment controls. Due to its modular design, we believe that our unit has the potential to be carried over into additional vehicle lines.

Also in Europe, we were awarded an insert molded assembly and a steering torque sensor using our magnetoelastic technology for the next-generation electronic power steering assist, or EPS system, for an all-terrain vehicle OEM. In Asia, our automotive segment was awarded a dome module for Great Wall. Combined these two programs represent approximately $7 million in annual revenue, launching in late FY17, running through FY20. Unfortunately, the previously announced program for passive door entry on Honda Odyssey vehicles has been cancelled. If you'll recall, Methode was a Tier 2 supplier for this project, and was scheduled to provide a sensor in the vehicle's door handle. The Tier 1 supplier lost the door handle business with Honda. This program would have launched in our FY17, with average annual revenue of $5 million for 5 years.

I would now like to update you on several of our new products and initiatives. First, our lithium ion-based uninterruptible power supply, or UPS, is designed to both protect IT equipment from power outages and to supplement the AC grid during peak energy consumption. This product was conceived, designed, and engineered by our Boulder-based engineering team, which we have named Active Energy Solutions. The AC6000 supplies 6,000 watts of power during the initial onset of a power outage until the on-site generator spins up. The unit contains highly efficient power electronics, a state-of-the-art lithium ion battery pack, and an innovative battery management system. The system has a rapid recharge rate, and peak shave capability to supplement power supply during high demand, with a seven-year battery life far surpassing lead-acid-based units.

During this quarter we achieved both UL certification of the unit and manufacturing line. The line was designed and built by our automotive manufacturing group who also oversees production. With pent-up demand of over 30 units, the first month of production was in full swing, satisfying initial orders. Additionally, we have reached an agreement with a European distributor, with an initial order for 10 units to be delivered in November, with estimated annual usage of 100 units from this customer. Average sales price on the AC6000 is approximately $8,000.

We also completed our first peak shaving proof of concept with a major data center in the US. The end result increased available power capacity by approximately 18% without going to the grid, which translates into millions of dollars of savings to a data center if fully implemented across the facility. The next [peer] will be a multi-month pilot over a larger footprint of the customer's facility. From a financial standpoint, we expect Active Energy Solutions to achieve break-even in our FY17, and long term become a key contributor to our EBITDA growth target.

As we discussed last quarter, our interface segment is focusing on solutions for vending and commercial food service equipment, moving away from appliances. In the first quarter, touch sensor continued to make progress in developing new opportunities in these markets. Specifically, they launched a touch sensitive user interface on a Pepsi-branded beverage dispenser manufactured by Cornelius, a Berkshire Hathaway Company, and one of the market leaders in beverage dispensing equipment. While this initial program is for small volume, we believe it will lead to other new product developments in both Cornelius and other OEMs.

Actually, touch sensor has a long history of serving OEMs in the food service equipment and vending markets. As an example, they have a 10-plus year supplier relationship with the Coca-Cola Company, shipping well over 0.5 million touch-sensitive user interface panels for equipment used to dispense various Coca-Cola-branded drinks. Given these long-term relationships and the growing trend within the commercial food service and vending markets to add solid-state touch-sensing controls and fluid-level sensing technology to their product offerings, we believe touch sensor will be able to leverage its impressive technology tool box to book meaningful awards in this area.

Moving to an update on Dabir Surfaces, over 500 successful surgical procedures have taken place using Dabir, with the majority being focused on cardiovascular cases. However, any procedure expected to exceed three to four hours in duration is a prime candidate for Dabir Surfaces. Dabir has also demonstrated value in procedures where patients are only partially sedated, but required to remain motionless for two to four hours.

Inquiries regarding non-surgical applications range from intensive care unit specialty beds to standard-care hospital beds with basic foam mattresses. Recent hospital ICU evaluations have shown improved patient comfort, improved caregiver ergonomics, and a potential for enhanced healing. I do want to stress, though, that any pressure ulcer treatment findings to date are considered very preliminary, and we are not currently marketing product on that basis. However, these positive indicators do warrant further clinical investigations, with studies planned over the next six to 12 months to substantiate.

Industry awareness of Dabir is rapidly increasing, including active engagement of several key opinion leaders in the wound care and clinical research specialties. Feedback and guidance from these individuals on our commercial value proposition and clinical benefit will drive continuous improvement of Dabir's product offering and services.

Additionally, CE certification of the product is almost complete, which will allow us -- will allow commercialization outside the United States. Government submissions have been made to enable access to the Veterans Administration health systems in early FY17. The Dabir team was also recently accepted as members of the Corporate Advisory Council on the National Pressure Ulcer Advisory Panel. This membership will enable real-time access to industry trends and opinions in education, public policy, research, and marketing. As I indicated on last quarter's call, we continue to generate a great deal of interest from the medical community with this product, and at this point feel adoption of this technology as a standard of care could become a reality.

Before I close, a quick comment on our China exposure. Less than 9% of our global sales go directly into the China market.

Now in summary, Methode's first-quarter sales were in line with our expectations, but gross margins and net income exceeded our expectations due to favorable currency translation and commodity pricing. It is difficult to know if these tail winds will continue. Additionally, we are proud to have announced our contract from a major North American OEM, who currently constitutes a substantial portion of the Company's annual automotive revenues.

Finally, we will continue to make investments in our business in new product development, vertical integration, and potential acquisitions. Further, we believe the initiation of a share repurchase program demonstrates our continued commitment to creating and returning value to our shareholders. Now I will turn the call over to Doug, who will give us further details.

Thanks, Don. Good morning, everyone. Looking at taxes, in the fourth quarter we released the valuation allowance related to Malta's previously generated investment tax credits. Going forward, Malta's portion of the effective tax rate will be effected both up and down by the amount of actual investment tax credit generated in the period. Therefore, based on our guidance the FY16 effective tax rate is expected to be in the mid-20% rate. For the first quarter of FY16, the tax rate was 23.9%.

Moving to capital expenditures, in the first quarter we spent $5.9 million. For the FY16 period, we are increasing expected capital spending to be between $25 million and $30 million. Expense for depreciation and amortization in the quarter was $6.2 million. For the fiscal year, we expect depreciation and amortization to be between $23 million and $26 million.

Moving to EBITDA, that was $36.9 million in the quarter, or just over 18% of sales. Based on our FY16 guidance, we expect EBITDA to be in the 15% to 16% range, or between $132 million and $143 million. Lastly, free cash flow for the quarter was $23.8 million. Based on our guidance and the increased capital spending estimate, we expect FY16 free cash flow to be between $80 million and $90 million. Don, that concludes my comments.

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

Thank you. At this time we'll be conducting a question-and-answer session.

(Operator Instructions)

Our first question today is coming from David Leiker from Robert W. Baird.

Good morning, everyone.

Good morning, David.

I want to start with -- and understanding the sensitivity with the customer, the large contract award, can you give us any qualitative commentary in terms of the relative content of what the new contract was versus the current one? If there's any volume changes? What we're seeing on some of these are what were sole supplier are getting split among multiple people? If there's any way you could provide some color on those things?

David, I appreciate you would like some more detail on that, but our customer was very gracious in understanding that we had to make some announcement because of the scale, but I must respect the customer's confidentiality, and I really can't comment any further.

Okay, I understand. I figured that was the answer. What about other automotive center stack opportunities, bidding activity for that? What does that outlook look like for you?

Well, we continue to make presentations, continue to bid. Generally, if we're in the hunt for something, we're fairly closed-lip on that for competitive reasons. As we announced today the HVAC unit for Renault, that starts out slow, but that's really a major win for our European growth. That will ramp to the $10 million, and could lead to other programs. We -- the larger programs are the touch screens and the integrated center consoles, but there are a number of customers that are starting to split that up a bit. We're in the hunt for those as well, but I do want to point out the Renault win. That's a long program that likely will go over more models.

That $20 million is a max if you're across multiple vehicle models there?

At least ramping to $10 million, I think is what we said.

$10 million?

Right. But that's book business. It could go higher if it goes onto more vehicles. But that's -- the $10 million is a contract award.

Okay, and then lastly, what's your thoughts in terms of the pace of buy-backs as you go forward here?

I don't know that we want to discuss that because that could influence the stock, but we do have our authorization and we'll proceed accordingly.

Okay, great. Thank you much.

Thank you. Our next question today is coming from Christopher Van Horn from FBR Capital.

Good morning, thanks for taking my call, and congrats on the quarter and the business win.

Thank you.

Could you comment on -- I know you've got now a $100-million buy-back in place, but there's still some cash left over and you've got a very solid free cash flow outlook. Can you comment on what you're seeing in the acquisition space, and where, if you can comment where you're focusing, and where possibly you're looking at your portfolio from a divestiture standpoint?

Sure, let me answer the second question first. It's difficult to comment on that, Chris, without making a lot of operations in Methode very nervous. What I'll say is we constantly look at our portfolio of companies, and as appropriate we would divest them. We have no plans at the moment, but that is something that at least once a year we review with our Board of Directors. Where that would make sense, we would certainly take that action. Even though it was a small divestiture, we did sell the Trace Labs last year.

But in terms of what we're looking at and what we're seeing, in certain ways you could say we're at the top of the cycle. When we look at maybe some automotive properties, those are pretty pricey because of where we are with the SAR. Our focus is more on industrial and medical, ideally something that would augment our De Beer surfaces, give us a quicker path to market is a target there. The industrial market, which we have seen has from our experiences with electronic has very good margin. The market somewhat lacks a company like Methode, where we can design, engineer, and furnish to very high quality on a global basis.

We feel an acquisition in that area wouldn't be as pricey as perhaps medical, and we are concentrating on that. We did retain a New York firm to seek out acquisitions for us, and we've been engaged with them for probably maybe about a year. We are -- our pipeline has improved significantly. Nothing to announce, but that is our key focus for our cash, in addition to our dividend and now the stock buy-back, and of course investing in our businesses.

Got it, great. Then just a couple mechanical questions, if you don't mind. The European auto business was down about 6%, and you said it's primarily due to currency. Do you have an organic number for that region within auto?

I'm not sure I -- organic?

Just ex-currency?

I don't know that we actually break out that.

Okay. Could you comment on the strength in Asia within auto -- very good numbers. Was it one program on the lead frame and on the steering angle sensor, or was it just a cumulative effect of all the programs over there?

It can be a little spotty, but our big program there is the lead frame. That is driven by our end customer sales. That's -- for automotive, that drives the bus there. That was up, and then steering angle sensor to a lesser degree.

Yes. Then the steering torque sensor you mentioned on the new business?

Yes.

Are you seeing the opportunities for that? That's a fairly new product, if I'm not mistaken. Are you seeing the opportunities for that really starting to ramp up, and is this a significant flagship win to start? How do we think about that?

It's actually -- the product has been out there for a while. We've been on the Bombardier -- I think they call it the Spider, the three wheel motorcycle with the two wheels up front. We've done steering torque sensing for them for quite some time. That was really our first major win for being on a vehicle. This is another platform, not with that customer. It's not new, but we are starting to see it becoming somewhat well accepted in off-road. Of course, the Spider was an over-the-road vehicle. I wouldn't call it new, but it's confirmation that technology truly works for that application.

Got it. Is it safe to say that this is more of a recreational type vehicle versus a on-the-road automobile?

In this application it is recreational off-road.

Okay, great. Thanks again, guys.

Oh, thank you.

Thank you. Our next question today is coming from Jimmy Baker from B. Riley & Company.

Hi, good morning. Congratulations on the large automotive win.

Good morning.

Could you tell us when you learned that you had won that major program?

Jimmy, I can't. It's probably not something we can discuss.

Okay, could you -- I'll try one more. Could you discuss why the last time you won a mega-program you independently press released that award, and were actually able to quantify the revenue opportunity? Can you speak to maybe what's changed, or if anything has changed that forced you to wait for the quarterly press release?

I can answer that. Since the announcement of the prior program, we really have gone to announcing wins on these calls. But also, our customer has tightened up their oversight of what suppliers can say and can't say. That award was a while ago, and things have changed since that time. As I said earlier, the customer was understanding of our need, but I also want to be understanding of their request for confidentiality.

Okay, sure. Then maybe revisiting your 9% to 10% five-year EBITDA CAGR target in light of the win. Could you speak to how that impacts your conviction in that target, realizing there are several puts and takes -- not just within automotive, but in your other segments? Maybe you could give us an updated holistic view on what remaining major factors are out there that you need to hit and execute to hit your target?

As I've said, we look out five years in great detail. This is because of the nature of our businesses. When we talked about that goal, we were very confident we could achieve it. Now the new business announcement does give us increased confidence in hitting that goal. Certainly, it was a key factor.

But in addition to automotive, there's a number of new products, probably the most that Methode's ever had on the docket -- 10 gig, and I talked about Active Energy, De Beer, and torque sensing, and others that we continue to work on. The combination of that -- again, our look-out five years, what we're seeing in center-console opportunities, whether it be a full center console or just a module like we talked about with Renault, and then again new products, give us confidence in obtaining that goal.

Sticking with automotive for a second, can you quantify the impact of the import duties refund that benefited gross margin? I assume that's non-recurring. Then circling back on the torque-sensing award, any update on getting that technology specced into the Holy Grail -- into transmissions at the automakers? Can you mention if the power sports OEM you've won was a North American OEM or Japanese?

The power sports was a European-based that has operations here in the United States. We've done business with them in the past. On the torque sensing on transmissions, progress continues, but I will say at a slower pace than we would like it. Transmission design is a little -- takes much longer than perhaps some of the other areas of the vehicle. It continues to move forward, but again, no announcement that we can make at this point.

I am pleased that the technology in general is seeing more and more applications. We talked about the off-road vehicle, but we've got the BMW ARS launching, that hopefully will go through other platforms. I'm pleased with the technology. We continue to make improvements in the technology, improvements in the manufacturing of the product; but as of this point no transmission award to announce. Doug, you can answer the --?

Sure. Jimmy, the import duties we -- that was $1.3 million.

Okay, understood. Last question, then. Hoping you could provide some visibility into the next major mile markers we should look for on the De Beer side of the business? I'm a little surprised you're not spending a little more there right now to accelerate the business. Do you see that spending -- that rate of spend -- increasing going forward before you would see material revenue, or is this $2 million to $2.5 million a quarter run rate the appropriate spend?

You must have been talking to our De Beer Group. We will increase the spend, and we may do some of that this year. We want to have a few more hospitals and some additional data, and then I think you'll see us do that. Once we get to that point, I think it would be very appropriate for Methode to spend more there. But that would come either later this year or in our FY17. But certainly we understand the need to do that.

Okay, great. Thanks very much for the time.

Thank you.

(Operator Instructions)

Our next question today is coming from Steve Dyer from Craig-Hallum.

Thanks for taking my question. Good morning, guys.

Good morning, Steve.

I don't want to keep beating a dead horse with respect to the new award. I'm just wondering, should we think about it in terms of it's for the same thing that you have right now, the same -- I don't want to say dollar content -- but in other words, currently if I'm thinking about this right, it's for the integrated center stack. This is not a step down to just an HVAC interface or something like that?

Yes, you are thinking about it correctly.

Okay, great. I think the existing award, at least as that customer has explained it, the existing award would go through something like 2018 before a redesign. Does this give you visibility then out to 2023-ish, something like that? Is that in the ball park?

That is in the ball park.

Okay. Then last question, as it pertains to that from a cost standpoint, I appreciate that you guys end up taking on a lot of development cost before ever recognizing revenue. Is that something we need to think about on the gross margin line, maybe not quite this early, but in the not too distant future?

Not necessarily, because when we were launching the first program, we did not have a lot of offsetting revenue for our engineering expenses. Engineering expenses for us is in cost of goods sold. We don't anticipate that we would have to add -- I think we have to add some engineering talent, but we won't be -- it shouldn't be affecting our gross margin, because we've got existing business to offset those expenses.

Yes, okay, that's helpful. Then as it relates to De Beer, can you remind us maybe what you have built in from a revenue perspective to your FY16 guidance, and maybe ball-park how we should think about that growing into the out year?

Very little built into our guidance. We have tasked the team to get on a certain run rate, likely at the latter half of the year, probably even into the fourth quarter. But we expect that De Beer will be a revenue generator and income generator. Let me back up -- a revenue generator when we may choose to take that income, to Jimmy's point, to reinvest in the business. But we do expect it to be a revenue contributor in our FY17.

Okay. Then I was pleased to see the buy-back, as I think probably a lot of people were. I know most of your cash is held overseas. Is your plan to pay taxes on a repatriation there, or are you going to pursue it at the rate in which you generate free cash flow or take a bank line, or any color there would be great?

Yes, Steve, we'll use just available cash balances; but also, we'll borrow on the credit line. That's relatively reasonable. It's LIBOR plus 1.5%. Again, we're paying for I think 4.4% for the commitment.

25 basis points.

25 basis points on the commitment invoice.

Yes. Then just to be clear, there's no buy-backs assumed in your EPS guidance for this year, is that right?

No.

Okay. Thanks a lot guys, appreciate it.

Thank you, Steve.

Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over to Management for any further or closing comments.

Thank you, Kevin. We'll close out the call, and wish everyone a very enjoyable and safe Labor Day holiday. Take care, now.

Thank you, that does conclude today's teleconference. You may disconnect your lines at this time.