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Methode Electronics Inc. (NYSE:MEI)

F2Q10 Earnings Call

December 10, 2009; 11:00 am ET

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

Operator

Greeting ladies and gentlemen and welcome to the Methode Electronics Incorporated fiscal 2010 Second 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 the small number of large consumers within the automotive industry; two, rising oil prices could affect our automotive consumer and 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 communications 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. Thank you Mr. Duda, you may now begin.

Donald Duda

Thank you Chris and good morning everyone. Thank you for joining us today for our fiscal 2010 second 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.

Methode’s performance of the second quarter of fiscal 2010 improved on a sequential basis for both our automotive and interconnect segments. With sales in both segments increasing over the first quarter of the previous year over this year. Additionally, even though consolidated revenues declined approximately 19% year over year, Methode achieved earnings per share of $0.06 of second quarter of this fiscal year, compared to $0.01 a year ago.

Additionally, consolidated gross margins improved to 22.1% in the second quarter compared to 20.2% for the same period last year. During the second quarter, net sale benefited by $1.7 million relating to a one time reversal of pricing contingencies which were approved over several years and are no longer required.

Additionally, the second quarters of both fiscal 10 and fiscal ’09 were impacted by restructuring charges, $3.2 million and $6.3 million respectively. If we remove these items, non-GAAP earnings per share were $0.10 in the second quarter of fiscal 10 compared to $0.11 in the same period of fiscal ’09.

Hence despite an almost 19% drop in sales, the non-GAAP earnings when we paid off slightly off a year ago number. We are very pleased with the sequential improvement in our interconnect segment. Although there was a year over year decline in sales, the segment did improve sequentially by nearly $6 million from the first quarter to the second quarter.

This revenue improvement was related to higher sales in touch sensor, Data Mate and Hetronic. Although second quarter automotive segment sales improved sequentially, there were a few items, which impacted the quarter both favorably and unfavorably and would impact our results in the second half of fiscal 2010.

In this segment, net sales to Delphi decreased $6.8 million in the quarter, compared to the second quarter last year. Additionally, Selling Administration expense included $1.5 million of legal fees relating to the Delphi litigation. Again, the third and fourth quarters fiscal 2010 will continue to be impacted by the cancellation of the Delphi supply agreement and the associated litigation expense, as well as continued volatility in all our business segments.

As I mentioned earlier, consolidated gross margins improved to 22.1% in the second quarter of 2010, compared to 20.2% in the same quarter of last year, excluding a $0.7 million asset write down relating to the termination of Delphi supply agreement and the $1.7 million reversal of pricing contingencies, as I talked about at the beginning of the call, consolidated non-GAAP gross margins still improved to 21.5%.

Throughout this fiscal year and last we’ve taken actions to align our expense levels with the expectation of a long challenging economic environment. The key objective was to lower our break-even and our results thus far in fiscal 2010 help validate our strategy.

In terms of liquidity and capital resources, we generated $7.9 million in net operating cash flow during the quarter, given our cash balance of $60.3 million coupled with no debt, we continue to enhance our ability to pursue and fund strategic initiatives despite the economic environment and the uncertainty in the credit markets.

We will continue to pursue complementary acquisitions and technologies that will help us grow our business. In the user interface or UI markets, we were awarded another contract for infotainment center councils from Ford on four additional models launching a model year 2013. Six distinct center stack two of which are Sony branded and all of which employ our touch sensor technology.

At full launch, we anticipate this award, combined with the previously announced Ford center stack business, which launches next spring, will generate approximately $40 million in annual sales. We thank Ford motor company for this business. Methode is also in final negotiation stages with a large Asian OEM for a global center stack program again utilizing touch sensor technology.

Lastly, our automotive engineers recently entered three technologies, Magneto-elastic, biometrics and field effect into the Annual Society of Automotive Engineers, MIT, vehicle innovation competition. All three technologies made it to the semi-finals and touch sensors field effect technology was one of the two finalists in this category.

Our field effect technology was also integrated into a fluid level sensor launched in the second quarter for a pump OEM. This represents one of the first significant uses of touch sensors technology for fluid level sensing. As I mentioned this last quarter, we’ve received a number of opportunities in our power product segment. Although, some of them may be small, we believe they will position us for larger opportunities the next fiscal year.

We remained very cautious about the second half of fiscal 2010, if you look at what has driven some sequential improvement in our automotive segments, I think there are number of underlying factors. First of all, it is clear that OEM inventory levels were reduced down to a very low point. So there was some restocking going on.

Secondly, there have been a number of incentive programs offered around the world, such as the cash flow congress programs in the US and likewise in Europe. Automotive increased sequentially based on automotive plants restarting production, and likely these incentive programs kicking in. Essentially, these short term incentives may have also driven some short term demand and possibly go-forward from later quarters. So, while we are very pleased to see this positive momentum I think the question we cannot answer today is, how sustainable this all this.

What we do know is based on the trends that we have seen, we anticipate our oil rate will slow in December, which is historically a lean sales month, and potentially in the first few months of calendar 2010. And frankly on a personal observation basis, I have not seen tremendous change in consumer sentiment.

However, in the long run, we see that our opportunity in all our end markets is take advantage of the increased sophistication and electronic content in our customers end products, this supports the realignment of our sales channel to concentrate on selling complete solutions, utilizing our ability to leverage the experience and technology of all our segments versus as in the past simply acting as a component vendor.

This effort is in its infancy but beginning to yield results, and while these opportunities will take some time to mature, they represents solid growth potential for Methode Electronics.

In closing, Methode technology and its ability to provide engineered solutions and manufacturing excellence worldwide will pave the way for our future growth, given our confidence in our technology offerings combined with improvement for our cost structure, we have an excellent opportunity to grow long term earnings.

With that, I would like to turn the meeting over to Doug for his financial comments.

Douglas Koman

Thanks Don, good morning everyone, let me start with a review of the sales gross margins and pre-taxed income for our reporting segments.

The automotive segment had second quarter sales of $56.2 million, that’s down 25% compared to 75.2 last year. For the six month period sales were $107.4 million down almost 33% compared to a $159.9 million last year. The decrease is due to the softening of the global economic environment, especially the effect on North American automotive industry.

Also this year, we had minimal sales to Chrysler in the quarter and six month period compared to last year, where we had $5.8 million in the quarter and $16.1 million in the six months period, we substantially had completed the transfer of Chrysler product by the end of last year’s second quarter.

Also sales to Delphi decreased $6.8 million in the second quarter and $9.8 million in the six month period. This is due to a combination of both the lower sales volume year-over-year and the cancellation of the supply arrangement effective September 2009.

Additionally, as Don pointed out sales in the both the second quarter and the six months period benefited from the reversal of the $1.7 million accrual for pricing contingences that are no longer required. In the quarter, we form sales were impacted by about 300,000 positively impacted in the second quarter, but for the six month period the foreign exchange decreased sales by about $1.3 million.

In the second quarter, gross margins for the automotive segment were $13 million or about 23% of sales compared to $15.8 million or 21% of sales last year. For the six months gross margins were $23.7 million or 22.1% of sales compared to $33.4 million or 20.9% of sales last year. Gross margins benefited from the $1.7 million accrual reversal however, they were negatively impacted by the $700,000 asset write down in the second quarter related to the termination of the Delphi supply arrangement.

Pre-tax income in the automotive segment was $5.6 million in the second quarter, compared to $6.2 million last year. For the six month period pre-tax income was $8.5 million, this year compared to $16.6 million last year.

The drop in pre-tax income was due to the lower sales volumes, the write down of Delphi related assets, legal fees related to the Delphi litigation, this was offset by the accrual reversal for the pricing contingencies and the fact that we had lower restructuring cost this year compared to last year, and also we saw the effect of lower cost resulting from our restructuring and consolidation efforts taken in prior period.

Moving to the interconnect segment, we had net sales of $30.5 million in the second quarter, which is down nearly 5% from $32 million in the last year. For the six months period, sales were $55.2 million down about 18% compared to $67.6 million last year. The decline reflects the general economic slow down in the market served by this segment and also our decision to exit certain legacy interconnect segment business.

Sales in the current quarter in six months included sales from Hetronic which was acquired on September 30th, 2008, so last year’s six month period only included one month of Hetronic sales. The currency translation have no impact on current sales in the second quarter, but it did decrease sales by about 300,000 in the six month period.

Second quarter gross margins for the interconnect segment were $7.1 million or 23.3% of sales compared to $7.3 million or 22.8% of sales last year. For the six month period gross margins were $13.4 million or 24.3% of sales compared to $16.3 million or 24.1% of sales last year. The increase in gross margin as a percentage of sales is primarily due to restructuring efforts taken in previous periods. This was offset by the effect of lower sales volumes.

Pre-tax income in the interconnect segment was $900,000 in the current quarter, compared to a loss of $2.5 million last year. The six month period pre-tax income was $1.2 million this year compared to a loss of $2.2 million last year. This is due to the lower intangible asset amortization this year and lower restructuring charges, this also was offset by the effect of lower sales volumes in this segment.

The power product segment sales were down 19% in the quarter, with $9.4 million this year compared to $11.6 million last year. Six months sales were $20.6 million down nearly 13% from $23.6 million last year. As with the other segments this was due to the general economic slow down resulting in the lower demand for our bus particular, cabling and heat sink products.

Gross margins in the power product segment were $2.1 million in the current quarter, the same as last year’s quarter. For the six months period gross margins were up slightly at $4.5 million compared to $4.4 million last year.

Gross margins and the percentage of sales increased to 22.3% in the current quarter compared to 18.1% last year. For the six month period gross margins were 21.8% this year compared to 18.6% last year. The percentage increase is primarily due to the restructuring initiatives and consolidation efforts in our US power products businesses.

Pre-tax income in the power product segment was a $0.5 million in the quarter, that’s the same as last year. For the six months period pre-tax income was $1.1 million compared to $1.3 million last year. This was due to the lower sales volumes and higher restructuring expenses partially offset by lower cost of product sold due to the impact of the restructuring and consolidation initiatives.

The other segment had second quarter sales of $2.4 million down slightly from $2.5 million last year. For the six months sales were up slightly to $5.1 million to $4.7 million last year. Gross margins were about a $100,000 this quarter compared to a negative gross margin of $100,000 last year. For the six month period gross margins were $200,000 this year compared to a $100,000 last year.

Pre-tax income in the other segment was a loss of $700,000 in the current quarter compared to a loss of 800,000 last year, for the six month period, the pretax loss was $1.3 million both this year and last year.

Some of the highlights on the consolidated income statement, selling and administrative expense in the second quarter was $16.4 million, down from $18.5 million last year in the six month period, selling and administrative was $32.3 million compared to $35 million last year. The decrease was due to lower expense for intangible asset amortization, and lower stock order amortization, partially offset by selling and administrative expenses from Hetronic and litigation expense related to the Delphi supply arrangement dispute, which was $1.5 million in the quarter and $1.9 million for the six month period.

As a percentage of sales, selling and administrative expense increased to 15.6% compared to 15.3% in last year’s quarter, and increased to 17.2% in the current six month period compared to 13.7% last year, the increase in selling and administrative as a percentage of sales reflects the significant drop in sales in the last half of fiscal 2009 and the Delphi litigation costs.

Interest income expense net was about break-even for the second quarter compared to income of 400,000 last year for the six month period we had interest expense of about a 100,000 compared to interest income of a million last year. The reduction is primarily due to significantly lower nominal interest rates this year versus last year, lower average cash balances this year compared to last year, and we also have fees related to the amendment of our bank facility during the first quarter of fiscal 2010.

Other income expense net was income of a 100,000 in the second quarter compared to an expense of 600,000 last year. For the six month period, we had an expense of 300,000 this year, compared to expense of 900,000 last year. The decrease is primarily due to weakening of the US dollar, compared to the Euro and the Czech Corona, which resulted in the loss of approximately $900,000 in the current six month period, and what was a gain of approximately $2.1 million in last year’s six month period.

Last year’s second quarter included an unrealized currency exchange loss of $2.5 million on an intercompany loan in connection with the Hetronic acquisition. In the current six month period, we reported a $600,000 gain on an enhanced cash fund, where last year we had recorded a loss of a half a million, and in this year’s quarter we have a $400,000 life insurance gain on the policies owned by the company in connection with an employee deferred compensation slab.

For the second quarter of fiscal 2010, the effective income tax rate was 9.7% compared with a benefit of 168.3% last year. For the six month period, the effective tax rate was 19.8% this year compared to 12.5% last year. The income tax expense in the second quarter of fiscal 2010 was 200,000 compared to a benefit of 900,000 in the second quarter of last year, and was in expense of a $0.5 million dollars in the current six month period compared to $1 million last year.

Normally, a tax benefit would be recorded relating to the loss, reporting of taxes for our US based businesses, however, due to the uncertainty of the future utilization of the tax benefit, evaluation allowance was recorded offsetting this benefit, both the quarter and the six month period reflect utilization of foreign investment tax credits and the effect of lower tax rates on the income of our foreign operations.

Briefly, looking at the balance sheet, cash increased to $60.3 million at the end of the second quarter compared to $54 million at year end. Accounts receivables balance is $71.8 million up from $60.4 million at the year end. Receivables are up primarily due to the higher sales in the second quarter versus the first quarter.

Inventory is $41.3 million, up from $40.4 million at year end. The increase is due primarily to higher customer funded tooling inventory for an insert molded transmission lead frame assembly being launched in Shanghai and this was offset by a decrease in product inventory due to aggressive inventory management.

Other current assets are $20.4 million down from $26.4 million at the end of last year. This is primarily due to a $4 million refund of fiscal 2009 estimated taxes, also a reclassification of tax assets from current to non current and amortization of prepaid insurance.

Property plant and equipment is at $68.4 million, this is down slightly from $69.9 million at the end of fiscal 2009, this is because depreciation slightly exceeded capital expenditures in the first six months. There is no change in goodwill from year end. Net intangible assets are $19.6 million down from $20.5 million at the end of last year. This is just due to normal amortization.

Other assets at $22.7 million are up from $21.9 million primarily due to adjustments between current and non-current deferred tax items offset by the decrease in cash surrender value on policies because of the payout of two policies. Accounts payable at $31.1 million was up from $24.5 million at year end primarily due to the higher sales in the second quarter versus the first quarter.

For the current liabilities at $27.9 million are down $1.1 million compared to $29 million at the end of the year due to the pay out and/or adjustments of various reserves such as product assurance, accrued vacation, workers compensation, medical, environmental VAT etc.

Other non-current liabilities at $16.5 million are down slightly from $16.9 million at the end of the year primarily due to deferred compensation payments. On the cash flow statement, the increase in cash and cash equivalents was $6.2 million in the first half of fiscal 2010. Cash provided by operating activities was $15.6 million, this is $13.8 million less than what was provided in the first half of fiscal 2009, primarily due to the decrease in business levels.

Cash used in investing activities was $6 million this year compared to $66.8 million last year. Last years activities included the acquisition of Hetronic and also we saw higher capital spending last year than this year.

Cash used in financing activities was $5.2 million. This compares to $9.5 million last year. Last year’s amount included $5.1 million for the repurchase of company’s stock. This year’s dividend payout is $700,000 higher due to the increase in the quarterly dividend. Finally, we also had a $1.9 million increase in cash due to the effect of foreign currency exchange rates on cash balances. Don that concludes my remarks.

Donald Duda

Well, thank you very much. Chris we are prepared 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

A handful of items here, if you look at and I mean you may have gone through this. But if you look at the revenue overall, you are up sequentially and if adjust further restructuring and the legal issues your profitability is generally flat. Is there anything in particular there that I’m missing as I look at it from that perspective?

Douglas Koman

You are looking at the sequential change?

David Leiker - Robert W. Baird

Yes. The revenues are up $10 million roughly and if you pull out the pricing issue that the gross profit, your gross profit looks like it’s flat. Just up about a few hundred thousand dollars.

Douglas Koman

I think we have been just focusing on the gross margin improvement and below the line we had again the $1.5 million of litigation expense related to dell pie?

David Leiker - Robert W. Baird

Right, that’s in SG&A line though, isn’t it?

Douglas Koman

Yes, I thought you were pointing to the pretax number.

David Leiker - Robert W. Baird

The gross profit number is roughly $15 million in both quarters, $15 to $16 million will be pull off the pricing itself and we will get follow up with this later if you want. I was just trying to get understanding by sequentially that the gross profit number wasn’t higher and the $10 million increase in revenue.

Douglas Koman

All right, let’s follow up on that.

David Leiker - Robert W. Baird

Okay. As we look at the Delphi, how much of an impact on revenue did that have, you would be ending up doubting what one month worth of Delphi in the numbers, is that right?

Douglas Koman

Yes. They cancelled it just about mid September so that would have been about a month and a half, but they were probably building some things a little bit, and If you look at the queue what we indicate there is that the number is down 6.8 in the quarter and compared to last year, and resulting in $6.6 million in sales in the quarter to Delphi.

David Leiker - Robert W. Baird

Okay, so that’s what your revenue in the quarter.

Douglas Koman

Right, that’s in our queue.

David Leiker - Robert W. Baird

Okay, and then, I know it’s a little touchy subject. But I mean there is a litigation cost, the magnitude and the time table of that I know is a little bit uncertain. But is there any thought you can give us that relates to that.

Donald Duda

We said in our six months.

Douglas Koman

Right. At one point we just told that the litigation these related to Delphi were $1.9 million.

David Leiker - Robert W. Baird

Was that in the quarter or is that a total amount that you in fact…

Douglas Koman

That’s a six month period. The quarter was $1.5 million.

David Leiker - Robert W. Baird

Okay. Looking forward can you give us any insight into what those numbers are going to be.

Donald Duda

I would maybe look, it is hard to say because litigation, when you are in court and in that position it's quite high, and then things go on to a little bit and it drop sound, if you can look at the six month average, that’s one way of looking at it, there is two pieces of litigation here, there is one in State Court there is one in Federal Court, I have done the agreement one is on the patents. I don’t know how much more I can say that, if I look at the run rate.

Operator

(Operator Instructions) Mr. Duda and Mr. Koman there are no further questions at this time. I would like to turn the floor back over to for any closing comments or remarks you may have.

Donald Duda

Thank you Chris, we’ll just thank everyone for listening today and wish everyone a pleasant day.

Operator

Ladies and gentlemen this does conclude our today’s teleconference. You may disconnect your lines at this time. And we thank you all for your participation. And you have a wonderful day.

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