Methode Electronics Inc (MEI) 2019 Q1 法說會逐字稿

Welcome to the Methode Electronics Fiscal Year 2019 First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

This conference call does contain forward-looking statements, which reflects management's expectations regarding future events and operating performance and speak only as of the date hereof. These forward-looking statements are subject to a 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 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 2 large automotive customers; dependence on the automotive, appliance, computer and communications industries; investment in programs prior to the recognition of revenue; timing, quality and cost of new program launches; uncertainties surrounding the completion and success of the Grakon acquisition; ability to withstand price pressure, including pricing reductions; currency fluctuations; customary risks related to conducting global operations; changes in U.S. trade policy; ability to successfully market and sell Dabir Surfaces; dependence on our supply chain; income tax rate fluctuations; dependence on the availability and price of raw materials; fluctuations in our gross margins; ability to withstand business interruptions; ability to keep pace with rapid technological changes; breach of our information technology systems; abilities to avoid design or manufacturing defects; ability to compete effectively; ability to protect our intellectual property; successfully benefit from acquisitions and divestitures; recognition of goodwill impairment charges; success of Pacific Insight and Procoplast and/or our ability to implement and profit from new applications of the acquired technologies; significant adjustments to expense based on the probability of meeting certain performance levels in our long-term incentive plan; 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 of Methode Electronics.

Thank you for joining us today for our fiscal 2019 first quarter financial results conference call. I'm joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I have comments, and afterwards we will take your questions.

Year-over-year fiscal 2019 first quarter sales increased 11% to $223.4 million and earnings per share increased from $0.55 to $0.63. First quarter earnings benefited from higher sales in the Automotive and Power Products segments, decreased stock award amortization and acquisition-related expenses, lower legal fees and a favorable currency impact from the weakening Mexican peso.

First quarter earnings were negatively impacted by selling and administrative expenses and increased intangible asset amortization expense, both attributable to the fiscal 2018 acquisitions and customer price reductions.

Compared to last year, consolidated gross margins decreased 70 basis points in the first quarter to 26.9%, negatively impacted by sales mix in the Automotive segment related to fiscal 2018 acquisitions and price reductions. This was substantially offset by a favorable mix in the Interface segment and higher sales volume in the Power Products segment as well as a favorable currency impact.

Year-over-year fiscal 2019 first quarter selling and administrative expenses decreased due primarily to lower acquisition-related stock award amortization expenses. This was partially offset by selling and administrative expenses from the fiscal 2018 acquisitions, which did not occur in last year's first quarter. Year-over-year fiscal 2019 first quarter pretax income was $28.2 million compared to $24.8 million. First quarter operating margin was 12.9% this year compared to 12.6% last year.

Moving on to a review of our segments. Year-over-year, Automotive segment sales increased 12% in the first quarter due to sales from the Procoplast and Pacific Insight acquisitions, and increased hidden switch, sensor and human machine interface product volumes. The improvements were partially offset by lower volume and price reductions of center consoles and transmission lead-frame assemblies, and decreased steering-angle sensor sales.

Year-over-year, Automotive gross margins declined 250 basis points to 26.8% in the first quarter due to sales mix related to our fiscal 2018 acquisitions and price reductions, partially mitigated by a favorable currency impact.

Moving to Interface. Year-over-year segments sales decreased 1.4% in the first quarter, driven mainly by lower client sales and the exit of Connectivity, which contributes $700,000 in sales in the first quarter of last year. These decreases were substantially offset by improved radio remote control sales. Compared to last year, Interface's gross margin increased 440 basis points to 26.2% from the first quarter, due to improved radio remote control sales and a favorable product mix.

First quarter Hetronic litigation costs were just under $1 million this fiscal year versus $2.9 million last year. We anticipate litigation costs to be $4 million to $5 million for fiscal 2019 and we currently anticipate litigation ending in fiscal 2019.

In our Power Products segment, sales increased year-over-year by 23.7% on first quarter due to higher PowerRail and busbar sales in North America and Asia. Year-over-year segment gross margins in the first quarter increased 220 basis points to 29.8%, primarily due to higher sales.

As we announced 10 days ago, Methode has agreed to acquire Grakon, a global leader in the design, development and manufacture of advanced lighting systems, controls and components for premier OEM manufacturers and the heavy truck, bus, rail, power sports and electric vehicle markets. Grakon sales teams have shared the news with their customers, many of whom are interested in Grakon's ability to bring additional technologies and more complex integrated solutions through the acquisition.

The news has also been received very positively by both Methode and Grakon employees who are excited to learn more about Methode's capabilities, and ways to leverage our complementary markets and growth opportunities. Both teams believe our companies sit very well together with cultures focused on delivering high-quality products, engineering solutions and growth through innovation. We expect the acquisition to close in September, subject to Hart-Scott-Rodino and customary closing conditions.

We'll update fiscal 2019 guidance based on the acquisition when our third-party valuation is finalized, a further analysis of predictive income is complete and transaction costs are settled. However, as we announced in the release this morning, we are reaffirming full year's guidance exclusive of the transaction and related cost and financial results of the Grakon acquisition.

The guidance ranges for fiscal 2019 are based upon management's expectations regarding a variety of factors and involve a number of risks and uncertainties, which have been detailed in this morning's release and Form 10-Q.

Before moving on to new business, I'd like to provide some insight as to our outlook on our North American Automotive business. As a reminder, our full year revenue for North American Automotive, exclusive of Pacific Insight, is projected to be lower this year over last year by about 6%, impacted by the price reductions of approximately $14 million on purchases placed, which I have discussed on previous calls, lower volumes of lead frames and certain integrated center consoles as well as contractual price concessions.

For the first quarter, revenue for North American auto, exclusive of Pacific Insight, was down about 10.5% over last year's first quarter, also impacted by the changeover of major platform by our largest customer. However, we do have significant amount of previously announced new business that will launch very late in this fiscal 2019 and early fiscal 2020, including 4 overhead console programs and an integrated tailgate module program, all new organic products for a total of approximately $21 million in revenue in fiscal 2020.

As far as new business in the first quarter. North American Automotive was awarded the overhead console for the next generation Ford Bronco SUV program, with a program life of 7 years, annual revenue is approximately $3.8 million beginning mid-fiscal 2021. They were also awarded a door activation switch program for Ford. The door handle is replaced by an activation switch and the driver's phone replaces the key fob. As the driver approaches the vehicle, the phone unlocks the door. With a program life of 6 years, average annual revenue is approximately $2.3 million beginning in fiscal 2021.

European Automotive was awarded their first electric vehicle program with Volkswagen to supply battery connection busbars and power distribution models -- modules utilizing complex insert-mold technology for the OEM's new electric vehicle platform. With average revenue of $8 million for 4 years, the program launches in fiscal 2020. Also, we were also awarded an additional HVAC control panel with Renault for their commercial vehicles. This program represents $6.5 million in average annual revenue beginning fiscal 2021 for 5 years.

Finally, McLaren awarded European Automotive, the complete set of interior switches as well as an innovative and stylish touchscreen and information displays for 2 new programs with average annual revenue of $2.5 million for 4 years beginning fiscal 2021. Asia Automotive was awarded a 4-year program with Great Wall Motors for touchscreen assembly for $23 million in average annual revenue launching in fiscal 2021. In total, these awards represent $38 million on organic growth beginning in fiscal 2021.

Now let's move on with an update on Dabir. During the first quarter, we saw the continued expansion of Dabir Surfaces within several of our current hospital sites. At Beaumont Health Network in Detroit, we expanded from the cardiovascular OR and electrophysiology lab to the surgical ICU. At Porter Hospital in Denver, we added the cardiovascular OR to the head/neck surgical OR. Cleveland Clinic extended their adoption of Dabir from the cardiovascular and transplant OR to neuro and plastic surgery. Lastly, Loma Linda University, a medical center near Los Angeles which began their adoption of Dabir in the OR, expanded this utilization to post-op recovery.

We also added 3 new customers: Aurora St. Luke's South Shore in Milwaukee has adopted Dabir for neurosurgery; Alberta Health Services in Edmonton, Canada, our first win in that market, has adopted Dabir for neurosurgery; while Parkview Health in Fort Wayne, Indiana, has adopted Dabir for all 14 of their ORs.

Additionally, we successfully completed evaluations at 6 hospital sites and began clinical evaluations at 6 additional hospitals. These evaluations are required as each hospital -- at each hospital prior to adoption with Dabir to demonstrate product efficacy in their particular application. Moreover, we are now engaged with several group purchasing organizations, or GPOs, as hospitals typically require new vendors to use their existing GPO relationship for procurements and contracts.

Earlier in the quarter, the Dabir-sponsored peer-review supplement to American nurses today titled, Pressure Injuries: Prevention Across the Acute-Care Continuum, was published and distributed to over 200,000 subscribers. The publication has received very good reviews and generated significant leads for our teams to pursue.

Now I will turn the call over to Ron, who will give further details regarding our financial results.

Thank you, Don. Good morning, everyone. I have a few brief comments on the quarter. Before I begin my commentary, I want to clarify that my comments do not include the impact of the acquisition of Grakon. As Don mentioned in his prepared comments, the company will incorporate Grakon into its guidance after the third-party valuation is finalized, the analysis of the projected income is complete and transaction-related costs are settled.

For the first quarter, the company reported an effective tax rate of 16%, this was primarily driven by the composition of the pretax income in regions with lower effective tax rates and the full benefit of lower rates in the U.S. due to tax reform, partially offset by some more favorable discrete adjustments in the fiscal 2018 period.

The final impacts of tax reform may differ from the amounts estimated due to, among other things, changes in interpretation of tax reform and legislative guidance. The company currently anticipates finalizing and recording any resulting adjustments within the 1-year allotted remeasurement period, which will occur in our third quarter of fiscal '19. We anticipate that our effective tax rate will normalize for fiscal year 2019 and estimate it to be in the range of 16% to 18%.

Turning our attention to SG&A, you will note that in the first quarter SG&A, inclusive of intangible amortization as a percentage of sales, was 14% compared to 15% in the prior year, resulting in a decrease of $1.1 million.

During the quarter, selling and administrative costs, excluding intangible amortization, decreased $100,000. However, the first quarter of this year included $3.6 million of cost associated with the Pacific Insight and Procoplast acquisitions. Absent these costs, selling and administrative costs decreased $3.7 million due to lower acquisition-related and stock award amortization and lower legal fees, partially offset by increased expenses for outside consulting fees, travel, wages and benefits.

Amortization of intangibles increased $1.2 million due to the amortization expense related to Pacific Insight and Procoplast acquisitions, neither of which were included in the first quarter results of fiscal 2018.

Moving on to capital expenditures. In fiscal '19 first quarter, we invested $18.2 million in the business, mainly to support programs and launches in North America and Europe. We are estimating capital investment in fiscal '19 to be in the $52 million to $58 million range.

Depreciation and amortization expense for the first quarter was $8.4 million. For fiscal 2019, we expect full year depreciation and amortization to be between $34 million and $36 million.

Shifting to EBITDA. The company generated $36.8 million in the quarter or 16.5% of sales. For fiscal 2019, we expect EBITDA to be between $161 million and $170 million or in the 16.5% to 17.5% of sales range. Free cash flow for the first quarter was $13.9 million. We expect fiscal '19 free cash flow to be between $85 million and $90 million.

Don, that concludes my comments.

Ron, thank you very much. Randa, we are ready to take questions.

(Operator Instructions) Our first question comes from the line of David Leiker with Robert W. Baird.

Let's see, where do I want to start. The Automotive contract awards. I guess a couple of things if you could find the way to kind of roll this together. But it looks like the pace of new contract awards are winning and the breadth of the customer and products is happening. Is this something in that ramp-up? I guess the question is, how sustainable is kind of that trajectory in this broadening customer product mix in terms of launches or contract awards?

It's always hard to predict from quarter-to-quarter what the awards are going to be. And as you know, we tend to bucket them in 75% probability, 50% in organic. And 70% -- 75% sometimes falls to the wayside and you find something in your embryonic that takes its place. So it's hard to predict.

But we have deliberately moved into overhead consoles. So we're talking about 4 wins there and they're not center console average sale price but they also don't have displays. So we deliberately did that. We're very pleased with what we've seen in electric vehicle, particularly the award on Volkswagen and that really says that we are a global supplier of products to EV.

Some of the wins we've got with Renault can continue, but it is very hard to predict. But the center consoles which -- now they've been around for quite a while, we're on our second major program. And there's price pressures there. So we branched out to where we think we can sustain our margins.

And then within that context, it seems like you are doing a great job of taking the existing -- I mean, it almost seems like you've got a product then as kind of an anchor with a customer and then cross sell different technologies into that same customer. That seems to be accelerating as well. Is that the right way to look at that?

If you're talking the anchor product being center consoles?

Well, I mean, center consoles but in some cases it might be something different like a busbar?

Yes, it -- that's our base strategy, is to bring our technology to our customers and help them make their products better, save them money, solve a problem. That's really our core strategy. And that does work.

And then the opposite -- go ahead, sorry.

No, we're just very -- we're pleased that we're seeing that. I was also very pleased to announce a touchscreen in Asia with the Great Wall. It was a nice win for our Asian group.

Yes, I agree. That is nice. And on the opposite side of this then, what's the pace of contracts going and the license rolling off on the back end? Is that a fairly stable number the next year or 2 or is there some changes in the way that that flows?

We're going to see our steering-angle sensor go end-of-life in Asia, not this year but next year. Last quarter I commented on our lead-frame business. That has always had peaks and valleys, but now we've seen several quarters of decline there. And that's T76 transmission, we're Tier 2 to Continental, that's 4 pass cars. At this point, we see that being down in the 20% range. And that's not scheduled to go end-of-life until I think 20...

'24.

'24. But it is pass car. So we have to take that into account.

Okay, I'm going to sneak one more in here. Similar kind of question on the nonautomotive side. I mean if you look at the pool of assets that you have of revenues you're generating outside of the Automotive business, that's also accelerating. How much of that is structural and repeatable? And how much of it might be timing or mix-related issues?

Let me talk about Power first. It's hard to predict that business. We've seen some great quarters and then we've seen -- because maybe mil-aero are spending down or our big data customer slowing down on their -- adding capacity on cloud computing. So it's hard to predict. But we're -- going forward for the duration of this year, we feel very confident in that.

We've also taken cost out of that business. And so the margins have improved nicely. Volume also helps in that business. It gets to a certain point and it has very good -- a good point in sales. And that has a very good flow through from that.

Hetronic, obviously, we spent a lot of money defending that business and we did that for a particular reason, and we want to protect that channel to market and we've done that, and that -- we're seeing the results of -- again, some structural changes in Hetronic. We now produce both in Monterrey, Mexico and in Egypt. So we've taken cost out, we've taken lead times out -- all the stuff that Methode does very well. And they're kind of the people to beat in that market right now.

Plus, with the acquisition of Grakon, we feel that we can bring some of the Grakon products to their customer base, for example, Manitowoc Cranes, that might be -- I'm just picking a customer there. So we do believe it's sustainable with the caveat that busbar can be a little spikey.

(Operator Instructions) Our next question comes from the line of Chris Van Horn with FBR.

Just to kind of continue on the path of these new awards. Any additional details. One of my questions was, on the door activation switch, is that just one program or is that going to be across the fleet for that customer? And then is this your first overhead win with Ford?

Let me answer the second question first. No, it's not. On the door activations switch, I -- we can't speak for the customer. Do we hope they carry it over to other platforms? Of course. But it is one award and we'll have to see what happens to that. But I can't -- that's a question you got to ask our customer.

Okay. No, got it. But it is -- the additional award is just for one program. Is that correct?

Correct.

Okay, got it. And then the EV win with VW. Is that similar to the work you're doing with Tesla, similar product line?

Yes. And then each OEM has their own particular battery design. But that's essentially it. And then there is a distribution module, it's -- loosely, you can call it a lead frame. It's complex insert molding, which we do very well. So it's a combination of the 2. That -- we're very pleased with that win.

Okay, got it. No, right, obviously, it expands that EV opportunity. And then the China win, I think, was really impressive. And what was -- what's kind of your domestic China exposure now? And then what does this kind of do to that?

Well, if it is -- I'm going from memory. But I'm fairly sure this is the largest award we received from a domestic OEM in China. Great Wall has been a good customer. We've got a good relationship with them. So our exposure is really with Great Wall. We have some other smaller business with some of the other OEMs. But it's really Great Wall.

And then of course, we do business with GM and Ford and others, which has been the majority of our, call it, domestic Chinese business. And now with Great Wall, that kind of starts to turn that the other way. So we're very pleased with that one.

Okay, great. Moving over to margins. How do we think about margin cadence for the rest of this year as you kind of get Procoplast and Pacific Insights more into the Methode margin profile. And then I apologize if I missed it, but did you ever give any sort of Grakon synergy opportunities that you see there?

Again, let me answer the second one first. No, we haven't given anything on synergies yet. We need to operate the company. And we know there's synergies and there's -- no, there's synergies in product, I mentioned about that with David's question on Hetronic. We also know that as we institute the Methode manufacturing system, there's cost we can take out of the factory and cost of quality and weaning out the factory.

They run a good factory. It's not a -- but we're an automotive supplier, so we'll implement our Methode manufacturing system. So there's things there that we will talk about. We're just -- we haven't operated it at this point.

Okay. And then, if you don't mind just kind of how we think about the margins and getting Procoplast...

Pacific Insight and Procoplast really, the margin improvement is really a 2020 event.

Yes.

They (technical difficulty) something at the end of the year but it's really more 2020. And I would say the same on Grakon, that's not something that we're going to come out of the box and immediately improve. That's probably more of a '22 event when you think about it. So it's about -- back of the napkin 18 months.

18 months.

Yes, before we see. And we're cautious. We don't want to go in and screw something up either, so we kind of take stock of where we are before we start implementing anything.

Okay, got it. And then last one for me, I'll jump back in the queue. The radio remote control business just continues to perform very well. Any specifics going on there? New customers, new wins or just continued business with existing customers. What's the dynamic there?

Kind of all of the above. There are new customers that reduced their lead time. And that's something we do across the board in our nonautomotive businesses is we want them to improve their lead time. So if their lead time was 6 weeks, we want to get it down to 2 weeks, because generally, the customer is not as concerned about the price.

Obviously, if you're doubling the price, you have an issue. But if you have the product, you get the business. And we've seen that in parts and we've implemented that in Hetronic. Hetronic team has done an excellent job of getting their lead times down.

But we've also introduced new products, different styles of remote controls. We've upgraded the display. So there's a number of things that we've done that have taken us a couple years to get there to improve the product offering, which has improved the business.

We've reached the end of our question-and-answer session. I'd like to turn the floor back to management for closing comments.

Randa, thank you very much. And I'll thank everybody for listening and the questions today, and wish everyone a very safe Labor Day holiday. Goodbye.

This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.