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Executives

Donald W. Duda – President, Chief Executive Officer & Director

Douglas A. Koman – Chief Financial Officer & Vice President Corporate Finance

Ronald L. G. Tsoumas – Treasure & Controller

Analysts

David Leiker – Robert W. Baird

[Fritz Voncart – Stage Asset Management]

Methode Electronics, Inc. (MEI) F1Q10 Earnings Call September 3, 2009 11:00 AM ET

Operator

Welcome to the Methode Electronics Incorporated fiscal 2010 first quarter 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 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 actual results to differ materially from our expectations are detailed in Methode’s filings with the Securities & Exchange Commission such as our annual and quarterly reports. Such factors may include without limitation the following: one, dependence on a small number of larger consumers within the automotive industry; two, rising oil prices could affect our automotive consumer future results; three, the seasonal and cyclical nature of some of our businesses; four, dependence on the automotive industry; five, dependence on the appliance, computer and communication industry; six, intense pricing pressures in the automotive industry; seven, increase in raw material prices; and eight, customary risks related to conducting global operations.

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

Donald W. Duda

Thank you for joining us today for our fiscal 2010 first quarter financial results 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 a 33% decline in net sales in the first quarter of fiscal 2010 compared to the same period last year Methode produced higher gross margins as a percent of sales as well as improved profitability in each of its primary operating segments. Additionally, gross margins, operating income and net income improved sequentially in this first quarter of fiscal 2010 compared to the third and fourth quarters of fiscal 2009. Furthermore, crisp execution by our global manufacturing teams coupled with careful management of our expenses enabled us to reach breakeven for the quarter and produce positive operating and free cash flow.

The 32% decline in sales in the first quarter was due in part to our decision to exit our legacy North American automotive business. Specifically, first quarter revenues excluded sales from Chrysler while last year’s quarter included revenues from this automaker. Additionally, as a result with Ford Motor Company to transfer all production at Methode’s Reynosa, Mexico facility to another supplier, sales to Ford were reduced in the first quarter. The transfer of Ford product was essentially completed last month.

Despite the significant lower sales volume, consolidated gross margins improved slightly to 22.6% of sales in the first quarter from 22.2% in the same period last year. The reasons were manufacturing efficiencies, a reduction in fixed cost and a favorable product mix. I also believe these results reinforced and validate our strategy to focus on higher margin business. These results were also driven by the significant restructurings we undertook.

Although the current global economic downturn has reduced our operating profit and earnings compared to the year ago period our quick reaction to the economic crisis and subsequent restructuring measures generated operating cash flow of $7.l7 million and $3 million of net cash in our first quarter while we also lowered fixed cost and product inventories. We expect to have our restructuring initiatives completed by the end of this fiscal year if not sooner.

Although there are some indication that some of our markets may be bottoming it is yet unclear whether this first quarter will be Methode’s bottom in terms of sales. One area of optimism we see is in our European business where there are positive signs that sales and profits are improving. Additionally, we are seeing increased quoting opportunities in our power products group over the prior six months. However, I want to caution that broad based improvement will still take some time to occur.

That said, the actions we have taken to reduce costs will help mitigated of lower sales while allowing us to continue to make critical investments for growth as markets improve. In the first quarter, we continued to solidify our user interface, sensor and power market positions and increase our prominence in new programs in a way that we expect will drive our results for many years. By working diligently to position Methode to capture new opportunities, we continue to diversify our business and expand our markets.

I would like to discuss some of our new business opportunities garnered in the first quarter. In our interconnect segment, we talked last quarter about our continuing efforts in the Asia Pacific region with TouchSensors technology focusing on vending machines. During the first quarter we were afforded the opportunity to develop the user interface for a major vending machine manufacturer in Europe. These opportunities represent significant diversification of the TouchSensors field effect technology originally launched in the appliance market and is a great example of our ability to expand our technology in to new geographic regions and to new customers.

In the US we continued to strengthen our position as the interface of choice for the appliance market as we were awarded new business for the user interface panel on a water dispensing system and free standing ranges that will both employ TouchSensor technology. Last quarter I also talked about a TouchSensor resolution touch screen as part of the user interface panel for a premium line of appliances. I am pleased to report that we commenced production during the quarter.

The integrated panel on these appliances enables a smooth style appearance while providing TouchSensor’s touch cells along with an innovative touch screen display which is behind four millimeter thick glass. This makes for a very robust touch screen but elegant display. We are not aware of anyone else in the market applying this type of product.

In our power product segment we will begin producing bus bars for [Bombardier] Locomotives for the Chinese market. This is our first order from [Bombardier’s] China division and represents the results of our global power products team working together specifically Methode Europe and Methode Asia. We congratulation the teams for this win.

We are also developing a bus bar along with a high current interconnect and power cable prototype for a new alternative energy power generating system. This step in to the alternative energy market will help better position us in this end market, it is another example of our power products groups working together to provide multiple solutions to our customers as they go through their product development process.

In the automotive market we have developed products that employee several of Methode’s technologies as their backbone including field effect, biometric and as discussed in our last call, Magnetoelastic sensors. For Jaguar and Mclaren we’re developing user interfaces for their new platforms. Both companies wanted a revolutionary new look and functionality for these interfaces and Methode was selected early in the concept and development phases to act in a collaborative role in the development of these new interfaces. These are all great examples of the evolution of Methode from a company that in the past just responded to RFQs to one that proactively provides solutions and technology to our customers.

I want to repeat what I said in July, we have innovative and patent technology and a global footprint which makes us, we believe, very well positioned to take advantage of the economic upswing that will certainly come and the accelerated growth that we will experience in developing markets. I am very optimistic for the future of Methode.

Finally, we are committed to maintaining our strong financial position even as we continue to invest in developing new technologies and introducing new products. We believe our $57 million in cash and no debt reflect a fiscal discipline that is meaningful to our investors especially in today’s uncertain environment.

With that I’d like to turn the call over to Doug for his financial review.

Douglas A. Koman

As usual, let me start by reviewing the sales gross margins and income before taxes for our reporting segments. The automotive segment had first quarter net sales of $51.2 million, down nearly 40% compared to the $84.7 million last year. The decrease is due to the softening of the global economic environment especially the effect on North American automotive industry. A large portion of the drop in sales is due to North American OEMs extending plant shut downs in to our first fiscal quarter.

Additionally, we had no sales to Chrysler this quarter compared to last year when we were still winding down that business. We had substantially completed the transfer of Chrysler product by the end of the second quarter of last fiscal year. Ford business was also being wound down in the current quarter compared to last year’s quarter.

Currency translation decreased foreign sales by $1.7 million in the quarter. In the first quarter gross margins for the automotive segment were $11.5 million compared to $17.7 million last year. Gross margins were positively impacted by restructuring initiatives taken in previous periods which helped to offset the lower sales volumes. As a percentage of sales gross margins were 22.5% in the first quarter of fiscal 2010 compared to 20.9% last year. Pre-tax income in the automotive segment was $2.8 million in the quarter compared to $10.5 million last year.

Moving to the interconnect segment, we had net sales of $24.7 million in the first quarter which is down nearly 31% from $35.6 million last year. Net sales in the current quarter include sales from Hetronic which was acquired on September 30, 2008. Excluding Hetronic sales, the remaining businesses in this segment were down about 43% in the first quarter. The decline reflects the general economic slowdown in the markets served by this segment and also our decision to exit certain legacy interconnect businesses.

Currency translation decreased foreign sales by about $300,000 in the first quarter. First quarter gross margins for the interconnect segment were $6.2 million or about 25.1% of sales compared to $9.1 million or 25.6% of sales last year. The decrease in gross margins as a percentage of sales is primarily due to manufacturing inefficiencies due to the lower sales volumes this year partially offset by gross margins from Hetronic. Pre-tax income in the interconnect segment was $200,000 in the current quarter compared to about $500,000 last year. This is due to higher cost of product sold as a result of lower sales volumes offset by lower restructuring charges and lower selling and administrative expense.

In the power product segment sales were down almost 7% in the quarter with $11.2 million this year compared to $12 million last year. As with the other segments, this was due to the general economic slowdown resulting in lower demand for our bus bar and heat sink products. Gross margins in the power product segment were $2.3 million, the same as last year’s quarter. Gross margins as a percentage of sales increased 21% in the current quarter compared to 19.2% last year. This increase is due to restructuring initiatives, consolidation efforts at our US power products businesses during the fourth quarter and also in the first quarter of 2010.

Pre-tax income in the power products segment was $600,000 in the quarter compared to about $800,000 last year. This was due to lower sales volumes, higher restructuring expenses and higher professional fees partially offset by lower cost of product sold due to the restructuring initiatives and consolidation efforts. The other segment had first quarter sales of $2.7 million which is up from $2.2 million last year. Sales at both our magnetic sensing business and testing laboratories were up year-over-year.

Gross margins were $200,000 in both the current quarter and also last year. That’s because the increase in net sales was offset by higher cost of products sold. Pre-tax income in the other segment was a loss of $600,000 in both the current quarter and last year. As with gross margins, the increase in net sales was offset by higher cost of products sold.

Some highlights on the consolidated income statement selling and administrative expense in the first quarter was $15.9 million down from $16.4 million. The decrease is due to lower intangible asset amortization and lower stock award amortization expense. That’s partially offset by selling and administrative expenses from Hetronic. However, as a percentage of net sales, selling and administrative expense increased to 17.7% compared to 12.2% in last year’s quarter. The increase in selling and administrative as a percent of sales reflects the significant drop in sales in the last half of fiscal 2009.

Interest income expense was an expense of $100,000 in the current quarter compared to income of $500,000 in last year’s quarter. The reduction is primarily due to lower nominal interest rates this year versus last year, lower average cash balances this year compared to last year because of the Hetronic acquisition and also we had fees related to the amendment of our bank facility during the first quarter of fiscal 2010.

Other expense net was $400,000 in the first quarter compared to $200,000 last year. The decrease is primarily due to weakening of the US dollar compared to the Euro and the Czech Koruna. For the first quarter of fiscal 2010 the effective tax rate was 109.6% compared to 21.6% last year. The income tax expense in the first quarter was $300,000 compared to $1.9 million last year. The reason for the higher effective tax was normally we would record a tax benefit relating to net losses before income taxes however, due to the uncertainty of the future utilization of the tax benefit a valuation allowance was recorded offsetting the tax benefit. This is because while the IRS allows a 20 year loss carry forward, the accounting rules prescribe that you look forward only a few years and therefore that’s the reason for the higher effective tax rate.

Looking at the balance sheet, as Don mentioned, we built up cash in the first quarter which is at $57.1 million compared to $54 million at the end of last year. Accounts receivable balance is $54.8 million, this is down from $60.4 million at the end of last year. Receivables are down primarily due to the lower sales in the first quarter. Inventory is $42.2 million which is up from $40.4 million at the end of last year. The increase is primarily due to higher customer funded tooling inventory for an insert modeled transmission lead frame assembly being launched in Shanghai.

This increase was offset by a decrease in product inventory due to lower sales in the quarter and also aggressive inventory management. Other current assets are $27.2 million. This is up from $26.4 million at the end of last year. This is primarily due to pre-paid insurance. Property, plant and equipment is $69.7 million. This is virtually unchanged from $69.9 million at the end of last year. There’s no change in goodwill. The change in intangible assets to $20 million down from $20.5 million is due to amortization expense.

Other assets at $22.5 million are up from $21.9 million primarily due to adjustments between current and non-current deferred tax items. Accounts payable at $25.1 million is up slightly from $24.5 million at the end of the year. Other current liabilities at $26.1 million are down $2.8 million compared to $29 million at the end of last fiscal year. This is due to payout and/or adjustments to various reserves such as product assurance, accrued vacation, workers comp, medical, legal, environmental and [inaudible].

Other non-current liabilities at $16.3 million are down slightly from $16.9 million at the end of the year primarily due to deferred compensation payments. Briefly, on the cash flow statement the increase in cash and cash equivalents was $3 million in the first quarter. Cash provided by operating activities was $7.7 million, this is $3.7 million less than what was provided in the first quarter of fiscal 2009 primarily due to the decrease in business levels. Cash used in investing activities was $3.4 million, that’s the same as last year.

Finally, cash used in financing activities is $2.6 million. This is $900,000 higher than last year. This is reflecting a higher dividend payout at $0.07 per share compared to $0.05 per share last year. This was slightly offset by no stock options being exercised this quarter compared to last year.

Donald W. Duda

We are ready to take questions.

Question-and-Answer Session

Operator

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

David Leiker – Robert W. Baird

I had to jump off and on a little bit today so I apologize if you touched on some of these but on the Delphi situation, how much of your Delphi revenue is related – is all of it related to this seat sensor?

Donald W. Duda

Yes, our AST division is completely dependent on the seat sensor, yes.

David Leiker – Robert W. Baird

But your Delphi revenue is 100% AST, right?

Donald W. Duda

Correct.

David Leiker – Robert W. Baird

Is there any other color that you can provide on this in terms of what your thoughts are of what happened here? It sounds like it was a little bit of a surprise to you?

Donald W. Duda

No, it wasn’t a surprise. As you might imagine, we’re going to be very guarded about what we say. We are involved in litigation with Delphi. It’s very difficult to say much more than that.

David Leiker – Robert W. Baird

On two other topics, if we look at your margin performance here in the quarter which is great, if you look sequentially at the prior quarter not year-over-year but sequentially on roughly the same revenue base you got almost a $20 million improvement in gross profit. Can you give us some broad buckets of what falls in to that and how much of that is really true underlying improvement in performance or if there’s anything in particular that we should be aware of as we look at that sequential profitability?

Douglas A. Koman

I think primarily I think we’re starting to see the benefit of a lot of the restructuring initiatives that we’ve been working on. That’s going to be the primary driver to the improvement in margins.

David Leiker – Robert W. Baird

But you got a $20 million improvement in cost savings from restructuring in a three month period, is that the way I should read that?

Douglas A. Koman

No, it’s not sequentially but I think I’d have to go back and look at what we had in the fourth quarter that might have been taking margins down a little bit. Because, if I looked sequentially on gross margins we did dip in the third and fourth quarter a little bit and now we’re coming back to a level that we’ve seen previously.

David Leiker – Robert W. Baird

Well, I’m looking at on the same revenue number you had a $4 million loss at the gross profit line in Q4 and you’ve got a $15 million profit on the same revenue number. I’m trying to get my arms around what the driver of that nearly $20 million improvement was but no change in revenue. Was there something changed in mix? I just want to try and get our arms around that?

Donald W. Duda

It’s a number of things. It certainly is the effect of some very dramatic restructurings, manufacturing efficiencies, a reduction on our fixed costs, to some degree favorable product mix from quarter-to-quarter and our focus on higher margin businesses. I don’t know what else we would say there. It validates or reinforces our restructuring efforts. Then, we’ve got things like less depreciation.

David Leiker – Robert W. Baird

So if we looked at, and I don’t want to get in to forecasting but, if we looked at your second quarter and said you had $90 million in revenue, would we expect you to generate $15 million in gross profit? Is there something in that thought process that we should adjust?

Douglas A. Koman

You’re looking at last year’s second quarter?

David Leiker – Robert W. Baird

No, this coming quarter, the quarter that we’re in the middle of right now, this October quarter? You did $90 million here in the July quarter, right. If you had $90 million in the October quarter, would you generate a gross profit of $15 million like you did in the first quarter or are there some things that we should be aware of in Q2 that will be different than Q1?

Donald W. Duda

In this regulatory environment I’m reluctant to –

David Leiker – Robert W. Baird

I’m giving it a $90 million number, I’m just trying to get a sense of what the pluses or minuses might be on margins in this current quarter versus the one that just finished? You don’t have to quantify it I just want to know what variables we should look at.

Donald W. Duda

I would say that it’s always dependent upon mix but, the only variable that we think we could point to is the effect of Delphi. We also said that Delphi is one of our more profitable divisions but we’re also seeing some upside in Europe so how that washes out in to a second quarter at a theoretical $90 million we’ll have to wait and see. But, I think that’s about as much color as we can give you on that.

David Leiker – Robert W. Baird

The last thing, if we looked on the revenue line as we go forward, just what the underlying trends are here over the next several quarters? Obviously, the end market is a little bit of a wild card, leave that outside of it but, in terms of volumes that are running off and new things that are starting off if you could give us some characterization of how that flow might look like over the next couple of quarters?

Donald W. Duda

I don’t think we have much product running off. We’re essentially done with our legacy auto.

Douglas A. Koman

We have less Ford going forward but we had some this quarter. Otherwise I don’t think I would say we don’t have anything running off but I don’t think we have anything significant launching that we would expect to impact the revenues. In the prior quarters that we were talking about sequentially, the gross margins, we did have some inventory write offs that would have negatively impacted those gross margins.

Operator

Your next question comes from [Fritz Voncart – Stage Asset Management].

[Fritz Voncart – Stage Asset Management]

I have kind of maybe like a little bit of a big picture question and you’ll just have to help me just because I’m a little bit new to your company. I’m not asking for any great secrets I’m just probably asking for things that other people already know. How would I think about the earnings power of your company sort of the upcoming cycle versus the last cycle? Again, I’m not looking for any great guidance but just where are the large differences, the obvious differences for the better or the worse in your company if we’re comparing on that time frame.

Donald W. Duda

As we mentioned Methode has in times past been probably almost as high as 80% dependent upon the automotive business. We have significantly reduced our exposure to that market but also changed within that market what products that we’re offering, more user interfaces, moving away from traditional switches as appropriate. So the first thing, as we move forward Methode has diversified itself. Then, we’ve also entered with some of our acquisitions, we’ve gone in to new really much larger markets where there is presumably better margins, interface electronics or human machine interface with the acquisition of TouchSensor and the acquisition of Hetronic.

So, we’ve entered I think a phase where our interconnect segment will ultimately grow and provide us higher margins. Also with power, the power group years ago was a very small group focusing on bus bars. We’ve added product lines both organic and through acquisitions that we have a pretty good offering for what I’ll call the high current market in power. Those tend to be at better margins than Methode historically has garnered.

We’ve positioned the company from a product segment standpoint. I’ll always point out that we’re not exiting auto, we’ve made adjustments in auto to shutoff some unprofitable business but, we’ll have our auto group, we’ll have our interconnect interface group and then our power products group and also our sensor area which is Magneto magnetic sensing that’s an investment that Methode has been making for years.

Again, Methode is positioned from a product standpoint but also as important not too many years ago most of our revenues came from the US. Now, we’re actually looking at a point where that’s probably going to go the other way at some point. Geographically we’ve expanded and we’ve consolidated our manufacturing facilities so that we have a global footprint but we have really three major manufacturing centers down from seven or eight of years ago. So, Methode has in the last couple of years repositioned itself so its future earnings again, it’s hard to predict, we need a little help from the world economy here but, I think Methode is well positioned from those two standpoints, from a product standpoint and a geographic standpoint and I would also mentioned a manufacturing standpoint.

[Fritz Voncart – Stage Asset Management]

Could I ask a follow up? Auto you said was 80% in the past and what is it now of your mix? It’s gone to what ballpark?

Donald W. Duda

In Q2 it was around 57% to 58%.

[Fritz Voncart – Stage Asset Management]

What are the couple of other big markets now that are now the bigger piece that have taken this space up from the auto?

Donald W. Duda

Well certainly interface electronics or what we refer to as HMI. We had a study done about a year ago that’s about a $20 billion market, about a $8 billion subset where we operate.

[Fritz Voncart – Stage Asset Management]

Those HMIs are those basically industrial?

Donald W. Duda

No. If you look at our TouchSensor business, they primarily got started in the appliance business.

[Fritz Voncart – Stage Asset Management]

I’m looking for the end markets.

Donald W. Duda

Appliance, there is certainly an industrial aspect of TouchSensors. The Hetronic acquisition is in construction and in transportation. One of their growing markets is in locomotives.

Douglas A. Koman

Material handling, mining, those kinds of things.

Donald W. Duda

But, what we look for is technologies or companies where they may be in a particular major market, TouchSensor was in appliances and that was because they were at one point owned by [Shot Glass] who wanted to put TouchSensor controls on their ceramic cook tops so they focused on appliance. So, TouchSensor grew up in that but it can also be used for level sensing, it can be used in industrial, it can be used in some of our new business wins in auto are using the TouchSensor technology. So, we tend to look for companies that have a technology that will go across markets.

[Fritz Voncart – Stage Asset Management]

The last follow up I promise, just in the auto, what’s your mix you know let’s call them American companies, the government effort plus Ford and the transplants and the foreigners, how does that mix break down roughly?

Douglas A. Koman

I don’t know that we’ve got the exact numbers but it’s heavily weighted in the Euro currently compared to what it was.

[Fritz Voncart – Stage Asset Management]

Your current auto exposure is predominately European now?

Donald W. Duda

What I should point out though is that we do ship product from our [inaudible] facility back to Ford in the US so there is a Ford element to that. But, to give you a little more background, I think in ’04 our revenues to Chrysler were about $104 million, don’t quote me that number, but around that range and we had zero last quarter. We have very limited business with GM and we have purposefully, we had to make some adjustments with Ford because we were having some issues in our Reynosa facility with product but we continue to work with Ford on a global basis. I don’t know what the mix will end up there.

Operator

We have no further questions at this time. I’d like to turn the floor back to management for closing comments.

Donald W. Duda

Thank you everyone for calling in and we wish everyone a pleasant day.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Methode Electronics, Inc. F1Q10 (Qtr End 08/01/09) Earnings Call Transcript
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