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Executives

Don Duda – President and CEO

Doug Koman – VP, Corporate Finance and CFO

Analysts

Keith Schicker – Robert W. Baird

Jeremy Hellman – Divine Capital Markets

Methode Electronics, Inc. (MEI) F3Q10 (Qtr End 01/30/10) Earnings Call March 4, 2010 11:00 AM ET

Operator

Greetings and welcome to the Methode Electronics Fiscal 2010 third quarter earnings. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) 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 statement 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 and Exchange Commission, such is our annual and quarterly report.

Such factors may include without limitations the following. Dependence on a small number of large customers, dependence on the automotive, appliance, computer and communications industries and construction, industrial, safety, radio remote control markets, seasonal and cyclical nature of some of our businesses, ability to protect our intellectual property or if we infringe or are alleged to infringe on another person's intellectual property, customary risks related to conducting global operations, ability to avoid design or manufacturing defects, ability to successfully benefit from acquisitions and acquire technology, ability to compete effectively in our technology based businesses and markets in which we operate, affect of acquisitions or divestiture of various business operations on our business, financial condition and operating results, ability to keep pace with rapid technological changes and dependence on the availability and price of raw materials.

It is now my pleasure to introduce your host, Don Duda, President and Chief Executive Officer for Methode Electronics. Thank you Mr. Duda, you may begin.

Don Duda

Thank you, Claudia and good morning, everyone. Thank you for joining us today for our fiscal 2010 third quarter financial results conference call. I'm 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.

Overall, I am relatively pleased with our third quarter results. The general economic climate continues to be extremely challenging for us and for many other global companies. However, third quarter 2010 consolidated sales increased just over 10% compared to the same quarter of last year, with sales improving in each of our segments.

Excluding restructuring charges in both periods and the impairment of goodwill and intangible asset charges in the fiscal 2009 third quarter, fiscal 2010 third quarter pre-tax loss improved $2.3 million on increased sales of $8.3 million over the third quarter of last year.

More importantly, on a year-over-year basis, third quarter gross margins also improved in each of our segments, primarily due to the impacts of the significant restructuring activities we undertook. Our consolidated gross margins were 17.2% in the current third quarter, compared to 13.7% in the prior year's quarter.

We have taken tough actions across the board to tighten expenses and reduce costs and are beginning to capitalize on the improvements we have made. We believe the benefit of these actions will increase as the economy slowly rebounds and our sales improve over time.

The Interconnect and Power Products segments were profitable in this third quarter, compared to losses in last year's third quarter. While the Automotive segment incurred a loss of $0.9 million in the quarter, our strategy to exit legacy automotive products improved the results for this segment almost 70% over last year's quarter.

Third quarter selling and administrative expenses increased from the third quarter of fiscal 2009, primarily as a result of $2.4 million in legal expenses relating to the Delphi Automotive Systems supply agreement and intellectual property litigation. Additionally, we also continued to make strategic investments in research and development of approximately $1 million per quarter.

On a sequential basis, comparing the third quarter with the second quarter of this fiscal year, we saw solid improvements in sales and strong improvement in gross margins in the Interconnect and Power Product segments. Third quarter Interconnect sales improved 10.8% from second quarter sales, while third quarter power product sales improved 2.1%.

Gross margins improved in the Interconnect segment to 28.1% in the third quarter from 23.3% in the second quarter of this fiscal year.

In our power product segment, gross margin improved to 27.1% in the third quarter from 22.3% in the second quarter of this fiscal year.

However, as anticipated, third quarter Automotive segment sales declined $12.6 million from the second quarter of this fiscal year, driven largely by lower sales to Delphi of $6.6 million, $3.4 million in reduced sales to Ford Motor Company as a result of the transfer of all production at Methode's Reynosa, Mexico facility to another Ford supplier and approximate $2.6 million, primarily related to programs going end of life, as planned.

Third quarter gross margins in the Automotive segment were 8%, down from 23% in the second quarter, likewise affected by the significantly reduced volumes and associated overhead coverage, as well as expenses associated with the sales and engineering efforts required to book and launch new programs to return Methode's North American automotive business to profitability.

A few other comments on North American Automotive business. First, our restructuring efforts are coming to an end and we believe we have successfully repositioned our North American automotive business for sustained growth and profitability.

Secondly, that said, the loss of the Delphi business was unexpected and will take some time to replace as it usually takes 18 to 24 months from date of an award to launch a new product in the automotive segment.

Third, necessarily, we continue to incur SG&A expenses in our North American automotive business beyond our current revenue levels to support the launch of new programs such as MyFord Touch as well as secure additional business.

Specifically regarding MyFord Touch, this business represents $12 million to $18 million in sales in fiscal 2011, ramping to $40 million in fiscal 2013. With business currently booked, we anticipate North American automotive business, short of legal expenses will break even in fiscal 2012.

Lastly, to further reduce SG&A expenses would dramatically impair Methode's ability to garner new opportunities, which represents significant future revenue potential for our North American automotive business.

Here are a few examples of the opportunities we are pursuing in the North American automotive. While the Ford integrated center stack business award was our first major booking utilizing TouchSensor technology in automotive, it was not the only business we have been pursuing. We continue to work with another U.S. automotive manufacturer and several Asian automakers on similar products.

The successful launch of the T-76 transmission lead-frame product has garnered additional opportunities for similar products with our current customers as well as others. As a background, T-76 is a General Motors transition platform used across several vehicles. Our customer provides a control unit and we provide a complex lead-frame assembly which must withstand the rigors of the transmission environment.

Also in transmissions, we continued to make significant progress using our magneto-elastic technology for a transmission torque sensor, which is being tested by several noteworthy automotive and transmission manufacturers. The units have survived rigorous environmental and test track protocols and thus far have performed well.

Again, utilizing magneto-elastic technology, we are working on the development of a torque sensor for an automotive air-conditioning – for automotive air-conditioning compressors for a major Tier 1, who supplies approximately 25% of the global automotive HVAC compressor requirements.

We are working on the development of a linear position sensor for a transmission application, again using magneto-elastic technology for a major U.S. automotive manufacturer. Our biometric sensor development is moving forward and we expect to have a formal development project with a major Asian automotive manufacturer this year.

While we may not win all these opportunities or control when they may launch, in total these opportunities represent in excess of $100 million in annual sales.

Moving back to Methode overall, the end markets related to some of our business units are demonstrating some signs of recovery, which can be seen in the improved sequential results in our Interconnect and Power Products segments.

Despite decreased sales for the nine months of this year over the fiscal 2009 nine-month period, which included Delphi's sales for the full period, I am pleased with our progress, with the performance of our people and the effectiveness of our strategy. Thus far this fiscal year, we have seen the beginning of the rebuilding of the revenue stream in each of our business segments as well as improving margins due to our extensive restructuring efforts and new product initiatives. However, while I feel confident about our long-term ability to capitalize on our plan, the near-term is less certain and we remain very guarded in our business outlook.

Turning now to new business awarded this quarter. We are seeing new business wins in the alternative energy and electric and hybrid vehicle markets, specifically in our power solutions group where we were awarded a laminated bus bar and power rail for the shipboard hybrid electric propulsion system for a leading defense contractor, the laminated bus bar for a battery pack retrofit for a hybrid electric vehicle manufacturer, the power distribution assembly for a lithium-ion battery pack for a manufacturer of commercial-scale, automotive-grade lithium-ion battery systems and lastly, the high current power distribution assembly for an inverter for a major developer and manufacturer of wind turbines.

These opportunities and other wins in our power group in the third quarter totaled over $3 million in annual sales.

Additionally in power, to date this fiscal year we have booked over $2 million of prototype and engineering sample orders. This is significant, as these orders have the potential to create over $16 million in annual revenue if we are sourced the corresponding production business.

In our interconnect segment we continue to help our customers differentiate their high-end appliances with awards in the third quarter for a TouchSensor using interface panels for a Thermador wall oven and for a Whirlpool range and oven. These wins, plus other interconnect business received in the third quarter, represent approximately $2 million in annual sales.

In our automotive segment, Methode was awarded a brake and clutch sensor for a French automaker, as well as a similar sensor for another major European auto manufacturer. Combined, these opportunities represent over $3 million in annual sales.

Moving forward, we will continue to seek opportunities that create not just revenue but value, value for our customers and certainly value for our shareholders.

With that, I'd like to turn the call over to Doug for his financial comments.

Doug Koman

Thank you, Don. Let me start with our reporting segments.

The automotive segment had third quarter sales of $43.6 million. That's up 19% compared to $36.6 million last year. In the nine-month period, sales were $151.6 million, down about 23% compared to $196.5 million last year. The increase in the third quarter is due to stronger sales in our European and Asian operations, primarily offset by sales to the Delphi – or no sales to Delphi. Last year's third quarter included sales to Delphi of about $9.3 million.

The decrease in sales for the nine-month period is, again, primarily due to sales – no sales to Delphi, which was a drop of about $19.2 million to $14.1 million this year, compared to $33.3 million last year.

In addition, we have minimal sales to Chrysler of about $1 million in the nine-month period compared to almost $17 million last year. As I mentioned on last quarter's call, we substantially completed the transfer of Chrysler product at the end of the second quarter of fiscal 2009.

Additionally, sales in the current nine-month period benefited from the reversal of about $1.7 million accrual for pricing contingencies and are no longer required.

Currency translation increased foreign sales by $1.7 million in the third quarter and increased foreign sales by about $400,000 in the nine-month period.

In the third quarter, gross margins for the automotive segment were $3.5 million, or 8% of sales, compared to $1.9 million or 5.2% of sales last year.

For the nine months, gross margins were $27.5 million or 18.1% of sales, compared to $35.4 million or 18% of sales last year.

In this year's third quarter, gross margins improved at our European and Asian operations but were offset primarily by the loss of the Delphi business. For the nine-month period, gross margins benefited from the $1.7 million accrual reversal for the pricing contingencies. However, gross margins were negatively affected by the loss of the Delphi business and the related $700,000 asset write-down in the second quarter related to the termination of the supply agreement.

In the automotive segment the pre-tax loss excluding restructuring and impairment charge was $0.5 million in this year's third quarter, compared to income of $100,000 last year.

For the nine-month period, pre-tax income and excluding restructuring and impairment charges, was $1.1 million this year, compared to income of $3.4 million last year.

In the third quarter we saw higher sales and gross margins being offset by the $2.4 million of legal fees relating to the Delphi dispute. Additionally, we had higher COBRA expense related to employees terminated due to the restructuring, but the accounting rules do not allow us to identify those costs as part of restructuring expense.

For the nine-month period, the lower pre-tax income was the result of the lower sales volumes, $4.3 million in legal fees related to the Delphi dispute, the $700,000 write-down of the Delphi-related assets and the higher COBRA expense. This was offset by the $1.7 million accrual reversal for pricing contingencies and lower costs resulting from our prior restructuring and consolidation efforts.

Interconnect segment had net sales of $33.8 million in the third quarter, which is up slightly from $33.2 million for last year. For the nine-month period, sales were $85.5 million, down about 12% compared to $100.8 million last year.

The increase in the quarter was primarily driven by strong sales in our user interface and data networking businesses in the US. This was offset by sales declines in Europe and Asia because of our exit of certain legacy interconnect business.

For the nine-month period the decrease in sales was primarily attributable to our decision to exit certain legacy interconnect business. This decline was offset by having nine months of sales from Hetronic this year, which was acquired on October 30, 2008, compared to last month's period, which included Hetronic for only four months.

Currency translation increased foreign sales by $200,000 in the third quarter but had decreased sales by $100,000 in the nine-month period. For the third quarter, gross margins for the Interconnect segment were $9.5 million or about 28% of sales compared to $7.1 million or 21.4% of sales last year.

For the nine-month period, gross margins were $23 million or 26% of sales compared to $25 million or 24.8% of sales last year. The increase in gross margins as a percentage of sales in the third quarter is primarily due to restructuring efforts taken in previous years.

Likewise, for the nine-month period the increase in gross margins as a percentage of sales is primarily due to our restructuring initiatives. This was offset however by the effect of the lower sales volume.

Pre-tax income in the Interconnect segment including restructuring and impairment charges, or excluding restructuring and impairment charges was $3.6 million in the current quarter, compared to income of about $0.5 million last year. This was primarily due to lower intangible asset amortization this year and lower selling and administrative expense due to our restructuring efforts.

In the nine-month period, pre-tax income excluding restructuring and impairment charges was $6.7 million this year, compared to income of $2.1 million last year. Similar to the third quarter, this is primarily due to lower intangible asset amortization this year and lower selling and administrative expense due to our restructuring efforts. However, this was offset by lower sales in the current nine-month period.

Power products segment sales were up slightly year-over-year for the quarter, with $9.6 million this year compared to $9.2 million last year. Nine-month sales were $30.1 million, down about 8% from $32.7 million last year.

The increase in the third quarter was driven by higher demand for our busbar products in the U.S. and Asia, offset by lower demand for cabling and heat sink products in the U.S. For the nine-month period, however, demand for all of our products was lower.

Gross margins in the power products segment were $2.6 million in the current quarter, compared to $1.2 million last year. For the nine-month period, gross margins were $7.1 million, compared to $5.4 million last year. Gross margins as a percentage of sales increased to 27.1% in the current quarter, compared to 13% last year.

For the nine-month period, gross margins as a percentage of sales were 23.6% this year, compared to 16.5% last year. The percentage increase is primarily due to the restructuring initiatives and consolidation efforts at our U.S. power products businesses.

Pre-tax income in the power products segment excluding restructuring and impairment charges was $1.2 million in the current quarter, compared to about $100,000 last year. For the nine-month period, pre-tax income excluding restructuring and impairment charges was $2.8 million, compared to $1.3 million last year.

This was due to improved gross margins offset by higher selling and administrative expense for both the quarter and the nine months. There were no significant changes to the other segment year-over-year, so I won't comment on that activity.

Some of the highlights on the consolidated income statement, selling and administrative expense in the third quarter was $17.1 million, up from $14.7 million last year. In the nine-month period, selling and administrative was $49.4 million, just about flat with $49.5 million last year.

Third quarter fiscal 2010 included $2.4 million in legal fees related to the dispute with Delphi. Additionally, selling and administrative expenses were unfavorable by $1.1 million. This is related to bonuses, professional fee and sales and marketing expense. This was offset by $1.1 million less net amortization expense for stock awards and intangible assets.

The slight decrease in the nine-month period was due to lower net amortization expense for stock awards and intangible assets, offset by the $4.3 million in legal fees related to the Delphi dispute.

As a percentage of net sales, selling and administrative expense increased to 19.2%, compared to 18.2% in last year's quarter and increased to 17.8% in the current nine-month period, compared to 14.7% in last year's nine-month period. The increase in selling and administrative expense as a percentage of sales reflects the Delphi litigation costs offset by the lower amortization expense and for the nine-month period, additionally reflects the significant drop in sales year over year.

Interest income net was down slightly, about $100,000 in the current quarter, compared to $200,000 last year. For the nine-month period, interest income was actually an expense of $100,000, compared to income of $1.2 million last year.

For the nine-month period, 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 had higher fees related to the amendment of our bank facility during the first quarter of fiscal 2010.

Other income expense net was income of $300,000 in the third quarter, compared to an expense of $300,000 last year. For the nine-month period we had zero other income this year, compared to an expense of $1.2 million last year.

The increase in the current quarter primarily relates to currency gains. The lost in last year's third quarter is primarily related to short-term investment activity. The increase in the current nine-month period primarily relates to the strengthening of the U.S. dollar and also includes a $400,000 gain realized on life insurance policies related to an employee deferred compensation plan.

Additionally during last year's nine-month period, we recorded a $2.5 million unrealized currency loss related to an intercompany loan between our corporate headquarters and one of our foreign business units. This was partially offset by currency gains in the same period.

For the third quarter of this year, the income tax expense was $2.3 million, compared to a benefit of $13.3 million last year. For the nine-month period, the income tax expense was $2.8 million this year, compared to a benefit of $12.3 million last year.

Since we had a book loss in the third quarter, you would expect to see a tax benefit recorded. However, due to the uncertainty of the future utilization of the U.S. generated tax benefits, an offsetting valuation allowance was recorded.

Also during the third quarter, we filed our fiscal 2009 federal tax return and recorded book to tax return adjustments of $2.8 million and other adjustments of $1.6 million. Offsetting this was a benefit of $2.7 million due to the settlement of uncertain tax decisions. Additionally in the third quarter, we recorded a $600,000 tax expense on foreign profits. And the nine-month period, the tax expense on foreign profits was $1.1 million.

Moving to the balance sheet, cash increased to $57.2 million at the end of the third quarter, compared to $54.0 million at year-end. The accounts receivable balance is $67.6 million. This is up from $60.4 million at the end of last year. Receivables are up primarily due to the higher sales.

Inventory is at $30.5 million. This is down from $37.2 million at the end of last fiscal year. The decrease here is due primarily to our aggressive inventory management.

Other current assets are $17.3 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 and the reclassification of tax assets from current to non-current due to the book to tax return adjustments.

Property, plant and equipment net at $65 million is down slightly from $69.9 million at the end of last year because depreciation expense exceeded capital expenditures and also due to the effect of currency valuation adjustments, primarily the euro, in the first nine months.

Goodwill is unchanged. Net intangible assets are $19.3 million. This is down from $20.5 million at the end of last year. This is due to normal amortization. Other assets are at $29.6 million. And this is up from $25 million at the end of last year.

You should note that we have broken out pre-production costs for customer-owned tooling inventory in a new line entitled pre-production costs. In the earnings release, financial highlights, preproduction costs are included in the other assets line item. And in the 10-Q is shown as a separate line item as a separate line item that's under the non-current section.

Formally, we had included pre-production costs in the inventory line. And pre-production costs for the period increased to $8.7 million from $3.2 million at the end of last year. This is primarily related to an insert molded transmission lead frame assembly being launched in Shanghai and the MyFord Touch electronic face plates in Monterrey, Mexico. Offsetting the increase in these costs in other assets, we had a decrease in the cash surrender value of life insurance policies because of the payout on two policies.

Accounts payable at $28 million was up from $24.5 million at the end of last year, primarily due to the higher sales in the third quarter versus the first quarter. Other current liabilities at $28.1 million are down slightly compared to $29.0 million at the end of last year, due to the payout and/or adjustment of various reserves such as product assurance, accrued vacation, worker's comp, medical, et cetera.

Other non-current liabilities at $12.8 million are down slightly from $16.9 million at the end of last year, primarily due to the take-down of reserve for uncertain tax position. And payments and adjustments related to deferred compensation plans.

On the cash flow statement, the increase in cash and cash equivalents was $3.2 million in the first nine months. Cash provided by operating activities was $15.9 million. This is $22.5 million less than was provided in the nine-month period of fiscal 2009, primarily due to the decrease in the business levels and less than expected tax benefits this year compared to last year.

Cash used in investing activities was $5.8 million this year, compared to $71 million last year. Last year's activities included $56.8 million for the acquisition of Hetronic and also for the higher capital spending. This year's activity also benefited from the proceeds received on the life insurance policies.

Cash used in financing activities was $7.8 million. This compares to $12.1 million last year. Last year's nine-month period included $5.1 million for the repurchase of company stock. This year's dividend payout is $700,000 higher due to the increase in the quarterly dividend.

Finally, we also had a $1 million increase in cash due to the effect of foreign currency exchange rates on cash balances. That concludes my remarks.

Don Duda

Doug. Thank you very much. Claudia, we are ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from David Leiker, Robert W. Baird. Please read your question.

Keith Schicker – Robert W. Baird

It's Keith Schicker on the line for David.

Don Duda

Good morning, Keith.

Keith Schicker – Robert W. Baird

I just want to start, I guess in the two non-automotive segments. You had pretty good profit recovery there with roughly consistent revenue here quarter-to-quarter. What's sort of driving the profit change there? And is that something that can continue going forward, or is there one-time or temporary issues there?

Don Duda

Well, certainly one quarter doesn't make a trend, but we have seen – the effects of our restructuring efforts have improved gross margins. Our power group I think is being much more selective in what type of business they are taking, leaning more towards military, aerospace and more niche-type products. I don't think that's an anomaly. I think that's certainly a trend. But again, we'll have to see what the next couple of quarters look like.

Our optical and data businesses, which are in the interconnect segment, had solid growth. They reached a certain point of revenue that they've become fairly profitable. And we saw that this quarter. That tends to be project by project, so that could slip back a little. Their project stream has been looking good going forward.

So, I would caution that though we have had good sequential growth, our restructuring efforts aren't going to go backwards, so those will stick. We'll just see what the next couple of quarters – it is highly mix-dependent, so I don't think it's an anomaly.

Keith Schicker – Robert W. Baird

Okay. And then if you look kind of going forward in those segments, you talked about some of the new areas where you are bidding on business and winning business. Are those the key growth drivers for those segments? Or are there any other areas where you think you can capitalize on that you haven't really tapped into yet?

Don Duda

I mean, I don't think – we are not going to do any more restructuring. I think we have done everything we should do there and I think anything else would be false economy and hurt the business. So, now as we've said in the past, we need to certainly book new business and we need some help from our existing customers in business that we have landed even a year ago.

We need those programs to launch at a higher rate than we have seen just because of the economy. So some help from the economy as well as new business wins is what's going to propel those businesses. And we continue to introduce new products in most of those business units.

Keith Schicker – Robert W. Baird

Okay. And then if we kind of step back and look across the whole business. If you look at the revenue opportunity for TouchSensor and some of the other newer technologies that you are starting to bring to market kind of a difficult question to answer, but how would you describe the scale of what you think the revenue opportunity is? Or the growth potential, just any sort of color you can offer in that respect?

Don Duda

Well, in auto I gave a fair amount of detail on the opportunities, we are working in and that's really not even all the opportunities. Those are the ones that are on our – I guess project tracker that come up to the executive level. And those are in excess of $100 million and we usually are pretty conservative. So I don't know how much more color I can give on the auto segment.

On the balance of the business, as I said to the earlier question it's new product initiatives that we have, it's mixing it up with a I guess more lucrative customer base in MIL-AERO in power. And in the Hetronic business we are seeing some of their end markets recovering slightly, although I would put the caveat that construction is still down. They have entered the locomotive remote control market, which is an area that they had not been in prior to the acquisition. That is giving them – that's gaining some traction, although as I seem to recall last month it was maybe $300,000 in business. But that's a fairly large market for them to pursue.

And then in TouchSensor, TouchSensor is – aside from auto they continue to pursue appliance. They're pursuing it in the European market as well. We are setting up production in Malta for TouchSensor transferring some business there that had been shipping into Europe. So it's an untapped market for them.

And they are also introducing a standard line of products where you can essentially buy a TouchSensor keypad and integrate that into your product in different face plates in Asia. So I mean all of those initiatives are really what our future revenue is going to be derived from. It is a difficult question to answer.

Keith Schicker – Robert W. Baird

Absolutely. And then just lastly here, you mentioned that in terms of the Ford interface that utilizes the Touch Technology, you've been talking with some other OEMs about that. Is that – have those talks begun since the product was introduced into the market? Or is that something that's been underway for a while? Or I guess alternatively how has the market reaction to the product been? And how have your customers reacted to the product?

Don Duda

I mean the answer to that is both. We've been talking to a number of automotive designers and customers prior to the MyFord Touch announcement and then of course MyFord Touch was very well received at the consumer electronics show, it was in the Chicago show. So that also helped garner some additional interest. I think what I mentioned in the prepared remarks those were all ongoing discussions that started some time ago.

Keith Schicker – Robert W. Baird

Okay. That's all I had. Thank you.

Don Duda

Keith, thank you very much.

Operator

(Operator Instructions) Our next question is coming from Jeremy Hellman with Divine Capital Markets. Please state your question.

Jeremy Hellman – Divine Capital Markets

Hi. Good morning, everybody.

Don Duda

Good morning, Jeremy.

Jeremy Hellman – Divine Capital Markets

With apologies I just wanted – I couldn't keep up with all you said during the prepared remarks. So I just wanted to go over a couple of items to make sure I got my notes right. First off, when you spoke about new business in the quarter in terms of the annual run rate on auto that $6 million was the number on that?

Doug Koman

I think it was $3 million, let me just check here. I'm almost positive it was $3 million for the quarter.

Jeremy Hellman – Divine Capital Markets

Okay.

Doug Koman

Yes.

Jeremy Hellman – Divine Capital Markets

$3 million. Okay. Good. And in terms of areas where you want business to get noted, in terms of electric energy there was some marine related power solution stuff, lithium-ion batteries and also some inverter work in wind turbine. And there was one other thing. I think it was electric vehicles or PHEVs, was that?

Don Duda

That was electric vehicles. Yeah, there was a bus bar for a defense contractor for shipboard use, a battery retrofit for a hybrid electric vehicle, the lithium-ion and an inverter for wind turbines.

Jeremy Hellman – Divine Capital Markets

Okay. So that kind of gets me to the question I had was when you kind of think about the opportunities going forward. A number of those items we just discussed are – can pick up a stimulus funding component to them. I know there was recently another $100 million of ARPA-E money that was announced and that goes to some storage technologies. For example, which would affect potentially lithium-ion makers, I know this may be asking you to capture a ghost, but do you see any delta in these areas of business with respect to stimulus money such that stimulus funds actually get spent in a meaningful way that that these potential customers will see a pickup on what they are doing?

Don Duda

The key question there is it meaningful way. But that's an excellent question and we are talking with potential customers that are slated to receive certain funding that would ultimately trickle down to us, as we are providing the power distribution systems. The caveat there is that what – that is an exciting market and it has a huge percentage growth, it's still on a very small base.

But it is a market that is on a lot of people's radar screens. It's certainly on ours and we – you are right. There are customers or people that are slated to receive funding and that will help us.

Jeremy Hellman – Divine Capital Markets

Okay.

Don Duda

But it has to be deployed and has to be funded.

Jeremy Hellman – Divine Capital Markets

Sure. Switching gears here on the Delphi litigation anything you can disclose in terms of expected legal costs this quarter that we are in? And going forward?

Don Duda

No. We had talked about how to answer that question. I would look at an average. It's so hard to predict what will happen in any litigation. And it goes I think in – goes up from…

Doug Koman

And kind of ebbs and flows.

Don Duda

Yes. Thank you. But I don't – I haven't looked at an average of what we've seen in the past.

Jeremy Hellman – Divine Capital Markets

Okay. Any key dates on the calendar coming up?

Don Duda

Key dates for…

Jeremy Hellman – Divine Capital Markets

For that litigation?

Don Duda

I don't – let me take a pass on that question, because I don't have anything in front of me on that.

Jeremy Hellman – Divine Capital Markets

Okay. No problem. And then lastly, just going back to – I think Keith I think it was Keith's margin related questions. Do you see – you kind of everything was framed in that will it retreat? Will margins retreat from where they are? As revenues pick up, one would expect some margin improvement mix being held constant obviously and as you noted, mix is key. Where – kind of thinking out a year or two segment by segment and I guess we can start with interconnect and power. Where do you think margins at a gross margin level could reasonably go to, or within a range?

Doug Koman

Let's talk about Interconnect. Our target – but first of all, I think maybe I've made this comment to you in the past. When we restructure these businesses and Methode went through a major, major restructuring. We looked at what we thought average revenues might be for the next couple of years, assuming that it's going to take certainly this calendar year before we see the world economy improving.

So we gear them to a – I won't say – well, I'll say a conservative revenue number. So what we expect assuming we don't have to add much back in the way of resources and we really shouldn't. You should get a pretty good throw from any top line growth, assuming you're not – you're material content is not 90%. So all the businesses of Methode have been geared to that and we've seen that start to occur in certain business units.

It's still a bit choppy. One month it might be up and the next month it's down. But we are confident that our efforts have – will bear fruit from that standpoint. So in Interconnect we are targeting the mid-20s for margins. It was at 28%? Now, could it go higher than that, depending on mix? So yes, but it also could drift down. It is mix dependent.

And in – unlike auto, where you are booking business for several years out and we know what type of revenues to expect and what the mix is going to be. You don't have that visibility in the Interconnect or the power market. But getting to power – the margins there, we are looking – we're targeting the low to mid-20s as the margin goal there. Again, that's highly mix dependent the more MIL-AERO, the more hybrid business we have, I think the higher the margins will be.

Jeremy Hellman – Divine Capital Markets

Okay. And then so going to auto and I – one on a hole in my notes was I believe you said you expected auto to be breakeven in fiscal '12. Was that correct?

Doug Koman

That's correct.

Jeremy Hellman – Divine Capital Markets

And that's operating, but at a gross margin level, right?

Don Duda

Right. And I would – I think what we said there is it was less any legal fees.

Jeremy Hellman – Divine Capital Markets

Right. Yeah. Okay. Just looking at more the near-term and also the long term with respect to automotive margins, any further color you can offer on where those go? Those have been highly volatile over the last number of quarters. Obviously, there's been a lot of interesting things for lack of a better descriptor going on in auto. So…

Don Duda

Let me answer the short-term. The automotive market is still very volatile. We have seen forecasts all over the map from our teams. And usually I get auto it's fairly predictable and certainly the last couple of years it has not been. So as I said in my remarks, I remain very cautious, certainly as we go into the fourth quarter and now in Q in the first quarter of next fiscal year. We will begin launching MyFord Touch, so we will get some contribution from that.

But the question there is that's slated for I think $12 to $18 million and that depends on how the vehicle is accepted. It doesn't really get to full launch until 2013. So near-term automotive margins are going to be under pressure and at best unpredictable, I would think. Long-term one of the reasons we went through and all the exit of the legacy products is that we weren't able to obtain the margins that we thought we needed to for the effort to go into being in the automotive market and the overhead structure that you maintain.

So long-term, I won't put a number on it yet, because we just – we haven't launched any of these new products. And but I can tell you that our goal is to certainly have better – much better margin than we've had in the past in auto. I realize that's a non-answer. But we just haven't launched the products and there's still too much uncertainty in the worldwide automotive market.

Jeremy Hellman – Divine Capital Markets

Right. Certainly, well, I guess a way I was kind of thinking about it. Where you spoke about, you have the kind of front-end, some related costs to set yourselves up to start delivering product. So provided there is no spike in those kind of costs in the current quarter. For example, under the MyFord Touch launch organically so to speak, we've seen that there would certainly be an upward drift to margins optically if utilization goes up?

Don Duda

Yes. Yeah. No. That's – if I use our Malta facility in Europe, we have seen when their margins or excuse me, when their revenues peak past a certain point. We see pretty good contribution. It's just not at a steady state right now. But no, you're absolutely right.

Jeremy Hellman – Divine Capital Markets

Okay. Thanks guys.

Don Duda

Thank you.

Operator

Gentlemen, it appears we have no further questions at this time. I'd like to turn the floor back over to management for any closing comments.

Don Duda

Thank you, Claudia. We will just thank everybody for listening and wish everybody a pleasant day. Thank you.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

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Source: Methode Electronics, Inc. F3Q10 (Qtr End 01/30/10) Earnings Call Transcript
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