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Methode Electronics, Inc. (MEI) F2Q09 Earnings Call

December 9, 2008 11:00 am ET

Executives

Donald Duda - President and Chief Executive Officer

Douglas Koman - Chief Financial Officer

Ronald Tsoumas - Controller

Analysts

Analyst for David Leiker - Robert W. Baird & Co., Inc.

Jeremy Holmen - Singular Research

Operator

Good day, ladies and gentlemen and welcome to the Methode Electronics, Inc. second quarter 2009 earnings conference call. At this time all participants are in a listen only mode and a brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.

This conference does contain certain forward-looking statements which reflect management’s expectations regarding future events and operating performance and speaks only as of the date hereof. These forward-looking statements are subject to the Safe Harbor Protection provided under securities laws. Methode undertakes no duty to update any forward-looking statements to conform the statement to actual results or change Methode’s expectations on a quarterly basis or otherwise. The forward-looking statements in this conference call involve a number of risks and uncertainties.

The factors that could cause actual results to differ materially from our expectations are detailed in Methode’s filings with the Securities and Exchange Commission such as our annual and quarterly reports. Such factors may include without limitation the following: 1) dependence on a small number of large consumers within the automotive industry; 2) rising oil prices could affect our automotive consumer’s future results; 3) the seasonal and cyclical nature of some of our business; 4) dependence on the automotive industry; 5) dependence on the appliance, computer and communications industry; 6) intense pricing pressures in the automotive industry; 7) increase in raw-material prices; and 8) customary risks related to conducting global operations.

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

Donald Duda

Thank you, Peter, and good morning everyone. Thank you for joining us today for our fiscal 2009 second quarter financial result conference call. I am joined today by Doug Koman, Chief Financial Officer, and Ron Tsoumas, Methode’s Controller. Both Doug and I have comments today and afterwards we will be pleased to take your questions.

Despite an increasingly challenging economic situation and the severe downturn in the worldwide automotive industry, we are pleased with our second quarter results. Increased penetration in the human machine interface, sensor, and power markets in the first six months of fiscal year 2009 was encouraging notwithstanding the severe downturn in our automotive segment.

Specifically, in Methode’s second quarter, net sales decreased $11.9 million or 8.9% to $121.3 million from $133.2 million in the second quarter of fiscal year 2008. In the second quarter, net income decreased $6.1 million to $2.7 million or $0.07 per share compared to $8.8 million or $0.24 per share in the second quarter of fiscal year 2008.

The decrease in net income is largely due to restructuring charges of $6.3 million incurred this quarter compared to no restructuring charges in the second quarter of fiscal year 2008 plus lower sales attributable to the softening of the global economic environment. Excluding the restructuring charge and the benefit of any Chrysler related price increases, Methode achieved net income of $5.4 million or $0.15 per share in the second quarter compared to $6.6 million or $0.18 per share in the same period of fiscal year 2008 again excluding any Chrysler-related price increases.

While we have made much progress diversifying Methode away from our legacy automotive products and customers, the events of the last few weeks necessitate that we will increase our efforts to further lessen Methode’s dependence on this troubled sector. To that end we have held discussions with certain automotive customers regarding their significantly reduced volumes which may necessitate action on Methode’s part. As the discussions are quite fluid this to the extent of the commentary I can provide at this time.

Through the second quarter of fiscal 2009, we have seen minimal impact to our business. However, we believe the US recession and slumping international economy will have a greater impact on our results in the third and fourth quarters of fiscal 2009.

It is our opinion that this recession will be protracted, lasting through calendar year 2009. While some economists have stated that we should begin to see a recovery in the second half of calendar year 2009, we are not that optimistic. As such, it is our intent to structure Methode and its business units for declining sales and will implement all actions necessary to properly position the operations as we enter Methode’s fiscal year 2010.

Some of the actions we are taking or considering include select price increases, head count reductions, consolidation of smaller operations, transfer of products, salvage furloughs, and exiting unprofitable business or product lines.

That said, I want to take a moment to discuss new business opportunities realized in the quarter. As we continue to focus on diversification by customer, market, and region, Methode’s global infrastructure, world class manufacturing skills, and excellent reputation continue to help win new programs. For instance, in human machine interface products, TouchSensors technologies was recently awarded a program to develop and manufacture a touch screen interface using a hybrid approach combining its proprietary field effect technology augmented by an off-the-shelf touch screen technology. The product launching next year will be supplied to a major manufacturer of appliances.

In the sensor area, and again using TouchSensor field effect technology, this time for fluid level sensing, the division is providing customer prototypes for a new solid state switch for sump and sewage pumps. These prototypes are being provided to two major pump manufacturers with products launching next year. An additional prototype for our water sensor is being supplied to an aerospace manufacturer for use on black boxes.

In the power segment, Methode continues to provide pre-production busbar products for electrical systems for the power converter used on electric or hybrid vehicles. Specifically in auto, we began production on a vehicle dynamic switch or VDS for [Fia Alfa] as well as a starter control unit on a new Volvo. We also launched a transmission division sensor for a Japanese OEM which is a unique smart position sensor using a Methode proprietary design. We estimate that these opportunities represent approximately $10 million in annual sales when fully launched.

These are important examples of our efforts to design, create, and introduce engineered solutions to our customers. We remain committed to investing in research and development activities to launch new products using our technology even as we traverse the increasingly challenging macroeconomic environment.

In summary, Methode’s balance sheet which includes $53 million in cash with no debt and a $75 million line of credit places the company in a strong financial position during his recession, not only to weather the downturn, but to be opportunistic on prospects which may present themselves.

At this point I will turn the call over to Doug for his financial review.

Douglas Koman

Thanks, Don. Morning, everyone. Let me start by reviewing sales and gross margin activity for our reporting segments. The automotive segment had second quarter net sales of $75.2 million compared to $89.8 million last year. That’s a 16.3% decrease in automotive product sales. For the six month period the automotive segment had net sales of $159.9 million compared to $172.7 million last year. That’s a 7.4% decrease in net sales. The decrease is due to lower global vehicle sales, especially for North American auto makers, and also reduced volumes due to our decision to exit Chrysler business.

Automotive sales were also impacted by price increases on Chrysler product of $2.2 million in the quarter and $7.3 million in the six month period. This compares to last year’s second quarter where we had $3.7 million of price increases and $5 million of price increases in the six month period last year.

The stronger US dollar negatively affected sales from our foreign operations by about $0.5 million this quarter and by $3.9 million for the six month period. In the second quarter gross margins for the automotive segment were $15 million or 19.9% of sales compared to $18.5 million or 20.6% of sales last year. For the six month period gross margins were $32.1 million or 20.1% of sales compared to $34.9 million or 20.2% of sales last year. The decrease in gross margin as a percentage of sales is primarily due to higher costs related to lower production volumes and a decline in sales volumes. The Chrysler price increases impacted gross margins for both the quarter and six month period for both this year and last year.

The interconnect segment had net sales of $32 million in the second quarter which is up 5.6% from $30.3 million last year. For the six month period, the interconnect segment had net sales of $67.6 million compared to $61.7 million last year. That’s a 9.6% increase in net sales. Sales were favorably impacted by the Hetronic acquisition which closed on September 30, 2008. The remaining businesses in this segment had slightly lower sales in the second quarter and slightly higher sales for the six month period. The lower sales in the second quarter reflect the weakness in the appliance, computer, and telecom industries.

Currency translation increased foreign sales by about $300,000 and $800,000 in the second quarter and six month period respectively. Gross margins for the interconnect segment were $8.8 million or 27.5% of sales compared to $6.7 million or 22.1% last year. For the six month period gross margins were $17.8 million or 26.3% of sales compared to $14.4 million or 23.3% of sales last year. The increase in percentage of sales is primarily the result of the Hetronic acquisition which currently has a lower cost of product sold than the other businesses in the segment.

Our other product segment sales were flat in the quarter with sales of 11.6 million this year and last year. For the six month period, sales were $23.6 million up from $20.7 million last year. The increase in the six month period primarily relates to the VEP acquisition that closed on August 31, 2007. We also have increased sales from our Asian operation.

Gross margins for the power products segment unfortunately decreased to $2.1 million or 18% of sales in the quarter from $3.1 million or 26.7%. For the six month period, gross margins decreased to $4.4 million or 18.6% from $5.7 million or 27.5% last year. The reduction is due to a product that reached end of life at the end of fiscal 2008 which had higher margins than business remaining in fiscal 2009. We also experienced an unfavorable product mix as well as higher labor cost and distribution costs in Shanghai.

The other segment had second quarter sales of $2.5 million up from $1.6 million last year. For the six year period the other segment had $4.7 million in sales compared to $3.2 million last year. The increase is due to higher sales from our torque sensing business and testing facilities.

Gross margins decreased to a loss of $100,000 from breakeven last year for the six months gross margins were about $100,000 positive this year and last year. The flat gross margin is primarily due to our continued investment initiatives in our torque sensing business.

Now turning to the rest of the consolidated income statement, selling and administrative expense in the second quarter was $18.7 million up from $16.1 million last year. As a percentage of net sales, selling, and administrative expense was 15.4% this quarter compared to 12.1% last year’s quarter. For the six month period selling and administrative was $35.2 million compared to $32.1 million last year. As a percentage of net sales, selling and administrative was 13.8% compared to 12.4% in last year’s six month period.

The increase in spending is primarily due to the Hetronic acquisition and higher amortization expense related to the TouchSensor and VEP acquisitions. The increase in percentage of sales is due to the higher amortization expense this year than last year related also to the TouchSensor and VEP acquisitions.

Interest income net was $400,000 in the second quarter compared to $600,000 last year. For the six month period interest income was $1 million both this year and last year. Reduction in the quarter is primarily because we are more heavily invested in tax free municipals this year compared to last year.

Other net went to a benefit of $1.9 million in the second quarter compared to an expense of $900,000 last year. For the six months other net went to a benefit of $1.6 million from an expense $1.2 million last year. This increase in benefit is substantially due to the impact of the strengthening dollar on the operations of some of our foreign operations.

The effective tax rate in the quarter was a benefit of 47.1% compared to an expense of 23% last year. For the six month period we saw the tax rate of 9.8% this year compared to 24.1% last year. The tax rate in both the quarter and six month period reflects the restructuring charges and the slowing business at our US based businesses. Both years reflect utilization of investment tax credits and the effective lower tax rates at the company’s foreign operations.

Looking at the balance sheet, cash is down to $52.8 million compared to $104.3 million at the end of last year. The year-over-year decrease in cash provided by operating activities was $12.7 million. This is primarily due to the decrease in net income in fiscal 2009, a significant customer prepayment that is reflected in the fiscal 2008 cash flows, and other working capital changes year-over-year.

The $48.6 million increase in cash used in investing activities is primarily due to the Hetronic acquisition in 2009 compared to the smaller VEP acquisition last year. The $7.1 million increase in cash used in financing activities is primarily due to the repurchase of our common stock in the second quarter and also that we have fewer stock options that were exercised this year compared to last year.

Continuing down the balance sheet, accounts receivable balance is $73.6 million down from $85.8 million at the end of fiscal 2008. In the current period, terms for significant automotive customer were changed from [2 net to 10] from about net 45 days. We also received payment on a large customer tooling project and the reduced sales in the second quarter also contributed to the decreased receivables.

Inventory is $68 million up from $55.9 million at year end. The increase is primarily due to the inventory from the Hetronic acquisition offset by inventory reductions at our businesses as a result of lower sales levels. There was no significant change in the balance of other current assets. It was $14.6 million this year compared to $14.9 million last year. Property, plant, and equipment net is at $80.4 million. This is down from $90.3 million at the end of last year. About $5.9 million of that drop is related to accelerated depreciation and impairment due to the restructuring. The balance of the change is due to currency translation of foreign denominated fixed assets due to the strengthening of the US dollar.

Good will is at $68.1 million. That’s up from $54.5 million at year end. This is primarily related to the Hetronic acquisition. Also intangible assets are $54.2 million up from $41.3 million at the end of last year, also this is due to the Hetronic acquisition, partially offset by normal amortization.

Other assets at $26.1 million are up slightly from $23.4 million primarily due to our investment in one of our technology partners and also an increase in the cash surrendered value of insurance policies.

Accounts payable at $32.9 million and this is down fro m$42.8 million at the end of last year and this is due to the lower business levels offset by payables that were recorded with the Hetronic acquisition. Other current liabilities at $25.7 million are down from $33.9 million at the end of last year, primarily this is due to the payment of estimated taxes and also less bonus expense being accrued this year versus last year.

Finally, other non-current liabilities at $21.8 million are up from $20.7 million at the end of last year primarily due to increased contributions into the deferred compensation plan partially offset by payments made under the bonus rights plan related to the TouchSensor acquisition.

That concludes my remarks.

Donald Duda

Thanks, Doug. Peter, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Leiker with Robert W. Baird.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

Can you just talk about how your business is kind of attracting this quarter so far versus the third quarter? Obviously the global economy has kind of slowed down pretty meaningfully in November and December here. Are you seeing that show up in your businesses or how is that tracking?

Donald Duda

As we said, we’ve seen a decline in order intake really across all our segments and around the world. It’s certainly not unique to the west. We’ve seen the power segment down, appliance, interconnect. Auto is probably the most meaningful but it certainly trumps all segments.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

So is it reasonable to expect it and I guess your revenues are going to be down in all your segments?

Douglas Koman

I’m trying not to give guidance here but suffice it to say Methode is probably going to follow the macroeconomic environment as we go into 2009.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

You’ve talked a little bit about looking at taking out of their [cut it] auto and maybe needing some more restructuring as things along those lines, is that in your kind of target for what your restructuring is going to be through 2010 or was that on top of the $5 million to $10 million you guys gave as a figure?

Donald Duda

What we’re doing, where we are, with all of our units based on what we anticipate to be a prolonged recession, so you take a look at any of the divisions and here in our third quarter and into our fourth quarter we’ll look at should there be some additional restructuring. I don’t think because auto is the largest that if we had costs it would approach, what was the number that we gave originally, 20 some million.

Douglas Koman

Up to $25 million.

Donald Duda

I don’t think we’d get anywhere near that, but we’re certainly going to take a look at all of Methode to see where we need to strengthen ourselves to traverse... it’s going to be a pretty tough business environment for the next 12 to 18 months and we would announce any...

Analyst for David Leiker - Robert W. Baird & Co., Inc.

I guess what I’m trying to get at, I think you said you’re looking at reducing your dependence on auto further. Would that require restructuring beyond what you’ve kind of laid out already?

Donald Duda

I think what we’re saying there is we’re looking and talking with our customers about the reduced volumes and which necessitates some actions on our part. Whether that’s price increases or moving product or other, that’s what we meant by that. I suppose in an extreme case that might trigger additional restructuring but it was really that we recognized the need to speak with our customers about their significantly reduced volumes and the effect that had on Methode.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

Can you talk about what your receivables exposure is [inaudible] OEMs at this point? It sounds like Chrysler should be pretty low by now. Is that fair?

Donald Duda

Yes, that’s fair.

Douglas Koman

Right now it depends on the payment schedules. Most of the OEMs pay once a month but on the average it comes out to about 45 days but right now General Motors is probably in a range of $3 to $3.5 million. Ford’s probably somewhere $7 million to $8 million. That includes a lot of Ford Europe. The Chrysler is currently tracking less than $1 million. This wouldn’t include any... we’ve got customer tooling products, that kind of stuff, those aren’t in these trade numbers that I just gave you the ranges on.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

What was the Chrysler number again?

Donald Duda

The Chrysler number is less than $1 million right now.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

I think you said in the press release that US was a tax loss in this quarter, you have the tax benefit, is that something that’s probably going to stick around for a couple of quarters?

Donald Duda

No, it’s primarily related to the restructuring.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

Right, but you guys talked about doing another $5 million or so a quarter of restructuring last couple of quarters?

Donald Duda

Right. As we get the benefit towards the restructuring, that obviously is at a much higher tax rate than we see outside the US.

Analyst for David Leiker - Robert W. Baird & Co., Inc.

So as the recession keeps pulling through, we could see additional losses in the US until that concludes?

Donald Duda

Yes either losses or a net benefit from the deduction, correct.

Operator

Your next question comes from Jeremy Holmen with Singular Research.

Jeremy Holmen - Singular Research

I was wondering, I don’t think I saw it anywhere and went through the Q kind of quickly this morning, but did you break out anywhere what the revenue contribution was in the quarter from Hetronic, you had it in for a month there.

Donald Duda

We did not break it out. We typically generally don’t report on the business units. I think the only indication we usually give would be the trending earnings when we announced the acquisition.

Jeremy Holmen - Singular Research

Kind of working down the income statement, the SG&A expense was up because of some costs related to the acquisition, how much if any of that was non-recurring, you know, legal fees or what have you, that might come out this quarter and forward?

Donald Duda

The bulk of that Jeremy is actually related to when we do the final purchase accounting and the customer relationship intangible is identified... that typically has a higher amortization in the first 2-3 years and then it will taper off. It’s more like a bell curve than straight line, so that’s where we’re seeing some increase in selling and administrative.

Jeremy Holmen - Singular Research

So that will stay with us for a little while then, right? Kind of speaking kind of qualitatively about the strategic landscaping, I would think from an outsider’s perspective that a lot of what will happen will be determined with the Big Three here in the US obviously, but are you seeing a lot of competitors who might have some strategic potential. Would you characterize the competitor marketplace as challenged with respect to their balance sheets or can you just kind of give us some flavor of how things stand out there?

Donald Duda

Speaking specifically about auto?

Jeremy Holmen - Singular Research

No, not necessarily I guess about auto, we kind of segued out of auto, I guess, sorry for the lack of clarity there, but just in general. You look at a recessionary economy, there are always going to be typically the weaker end up being victims of the stronger. I’m wondering if you’re really seeing that play out.

Donald Duda

We hope to see that played out but having been through this once or twice before, you have to go through a period of time with your competitors, your weaker competitors, where there’s, for lack of a better word, a desperation phase where you’ll actually see prices drop for a bit because some cash is better than no cash and they try to keep the doors open by bringing in some business. You have to go through that phase. It may happen quicker because there’s not readily cash available from the banks but I think we have to go through that phase first. We’ve reviewed each of our competitors in most of our businesses and we’ll take a wait and see approach but I think we’re in that phase of having to go through maybe a couple more months of turmoil before you see some fall out from that or some opportunities. I firmly believe there’s going to be some opportunities.

Jeremy Holmen - Singular Research

When you were talking about some of the steps that you’re working on that may need to be considered with the strike in the auto business, I know you guys have had some platform when you’re looking to be included on in 2010 and so forth. Are you seeing anything that has been having towards the side of being canceled or volume reductions or... I know you could have said you didn’t really want to get into much detail there, but --

Douglas Koman

We are reviewing around the world all of our auto programs. As the press talks about the US auto market, but you’re seeing declining sales in Europe and Asia, so we routinely go through the programs and look at costs and [inaudible]. Now we’re going through probably much closer and trying to anticipate what the reductions are going to be. Clearly there’s going to be some reductions there and we’ll have discussions with our customers based on what we see. I don’t know how all the programs worldwide for any auto maker or supplier are going to stay at the numbers that were projected a year or two ago.

Jeremy Holmen - Singular Research

If you’re looking at the next administration and varying stories around about what kind of stimulus will be brought to bear and to what quantity, where is your, beyond just auto, but looking at your business all inclusive, if there’s a real heavy renewable and that sort of thing, you have some products to go into varying components and such. Do you stand to be very large beneficiary, it will help, can you characterize that to any extent?

Donald Duda

If you look at auto, everything, the bailout money’s probably helped to protect receivables and I still think there’s reduced volumes and that’s just forestalling the inevitable. Is there a benefit to that? Probably not in the US. There might be in Europe or as the European countries help the automakers. We may see a benefit up from that. A probably bigger benefit might come in the power segment, renewable energy, it really depends on how the administration spends their money and how quickly. It’s one thing from the past, another thing to get the money to go out the door. I think they’ve only spent half of the money on the financial bailout. Will it have an effect in the next 12 months? I wouldn’t think so, I think it’s probably 12 to 18 months out.

Operator

(Operator Instructions)

Donald Duda

Peter, if there are no further questions, we will conclude the call and wish everybody a good day.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. Thank you again for joining us today.

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Source: Methode Electronics, Inc. F2Q09 (Qtr End 11/01/08) Earnings Call Transcript
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