Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Douglas Koman - Chief Financial Officer, Principal Accounting Officer and Vice President of Corporate Finance

Donald Duda - Chief Executive Officer, President and Director

Analysts

Jeremy Hellman - Singular Research

Joseph Vruwink

Methode Electronics (MEI) Q3 2011 Earnings Call March 3, 2011 11:00 AM ET

Operator

Greetings, and welcome to the Methode Electronics Fiscal 2011 Third Quarter Earnings Presentation. [Operator Instructions]

This conference call does contain certain forward-looking statements, which reflects management's expectations regarding future events and operating performances, 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 as our annual and quarterly reports. Such factors may include, without limitations, the following: dependence on a small number of large customers, including two large Automotive customers; dependence on the Automotive, appliance, computer and communications industries; seasonal and cyclical nature of some of our businesses; dependence on the availability, price and risk of substitution or counterfeit of components and raw materials; rising crude oil prices may result in higher costs for resin and other petroleum-based material; ability to compete effectively; customary risks related to conducting global operations; ability to keep pace with rapid technological changes; ability to avoid design or manufacturing defects; currency fluctuations; ability to protect our intellectual property; ability to successfully benefit from acquisitions; unfavorable tax laws; the future trading price of our stock; and the risk of owning real property.

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

Donald Duda

Thank you, Christine, and good morning, everyone. Thank you for joining us today for our fiscal 2011 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.

In the third quarter of fiscal 2011, Methode achieved solid sales improvement, with sales up 13.7% compared to the same period last year, and 10.4% for the nine-month period. In our Automotive segment, we experienced higher sales in our transmission lead frame, and steering-angle sensor products, as well as from the MyFord Touch center console program. Our Power Products segment also had strong sales. Interconnect sales were down, primarily as a result of Whirlpool, significantly reducing their requirements for TouchSensor products during the quarter, as a result of lower appliance sales. Adjusting the nine-month results for the loss of sales to Delphi, and planned lower sales of legacy Automotive products, which together totaled $24.3 million, consolidated sales in the nine months of fiscal 2011 increased 21%.

As we announced this morning, Methode settled the Blue Angel matter for $2.1 million. This resulted in a $1.7 million reversal off the $3.8 million expense we recorded in the second quarter, resulting in a benefit to net income in the third quarter, but a negative impact on earnings in the nine-month period. Additionally, we have several expenses and benefits in the third quarter and nine-month period that make an apples-to-apples comparison a little difficult. Doug will expand upon these in his discussion.

Consolidated gross margins were 19.2% compared to 17.2% a year ago. This was attributable mainly to higher sales, as well as margin improvement in our Automotive segment, partially offset by manufacturing inefficiencies related to multiple product launches, which I will talk about more in a moment.

In the first nine months, consolidated gross margins were 20.7% in both this year's and last year's period. Even though our sales increased year-over-year, gross margins remained constant due to loss of sales to Delphi, which was a higher margin business line for us, as well as other charges and costs that Doug will discuss shortly. While we believe the particular vendor supply and delivery issues we experienced in the second and third quarters have been resolved, we may, however, continue to experience manufacturing inefficiencies in the next few quarters due to multiple product launches, as well as component shortages, which also hamper our production efficiencies.

Some additional detail on the segment results. In this third quarter, Automotive segment sales improved over 20% year-over-year. As I mentioned, this was due to higher sales in our transmission lead frame and steering-angle sensor products in Asia, and the MyFord Touch center console program here in North America. Sequentially, we saw a 4% drop in overall Automotive sales from the second quarter due to seasonality, as December is typically our slowest month of the year, as well as the aforementioned drop in European sales.

Sales were up close to 3% in the Automotive segment in a nine-month comparison, but were negatively impacted by the loss of sales to Delphi, and the planned lower sales of legacy Automotive products. If we take out these two items, Automotive segment sales increased almost 23% in the first nine months of fiscal 2011 compared to 2010. The planned transfer of the manufacturing of the T-76 lead frame product from the U.S. to China skewed our North American Automotive segment sales for the nine-month period. Excluding the loss of sales of Delphi, the planned lower sales of legacy Automotive products and the transfer of the T-76 business, North American Automotive segment sales were up about 37% in the first nine months, primarily the result of the continued launch of the MyFord Touch center console program.

Automotive segment gross margins improved substantially in this third quarter over 2010, more than doubling from 8% to over 17%, despite the vendor issues and manufacturing inefficiencies. These additional costs were the consequence of a record number of new product launches. As in the past, we have instituted our corrective actions, and anticipate as we progress through the launches into full production, these issues will be behind us. In the nine-month period, Automotive segment gross margins improved modestly despite the loss of a higher-margin Delphi business, and the aforementioned costs.

Interconnect sales decreased almost 4% in this third quarter compared to last year, attributable mainly to the planned exit of legacy connector products in Asia and the lower planned sales in North America, which affected our TouchSensor business. These lower sales were partially offset by increased sales of safety remote control products compared to the third quarter of fiscal 2010. Sequentially, third quarter Interconnect sales were down almost 11%, again mainly due to the reduced appliance sales, which we expect to continue into Methode's fourth quarter. Despite slower business, Interconnect margins in the third quarter and the first nine months are at the high-end of our target for this business segment due primarily to a good sales mix.

Power product sales were up significantly in the third quarter and the first nine months, has certain awards we received in the fiscal 2009, had moved to the design and testing stages, and have commenced production. In the third quarter, sales were up over 35% as a result of higher flexible cabling, heat sink and bus bar demand. Sales for the nine months were up over 21%, as a result of higher bus bar demand, and new introduction of Power Products into Europe.

Sequentially, third quarter Power Products sales were up over 8% over the second quarter, and were particularly strong in our North American segment. While gross margins decreased year-over-year, this was mainly due to a product development cost of approximately $700,000 for a new award that I will discuss in a moment. In a nine-month comparison, gross margins decreased due to a customer program cancellation and associated expenses, which we are seeking to recover, as well as the new product development cost I just mentioned.

On to new business wins and ongoing solutions development for our customers. In the first quarter of this fiscal year, we announced that our MDI group was awarded a contract to provide a top-tier Automotive OEM, with a custom sensor, using our Magneto-Elastic technology for the measurement of clutch plate position in a new fuel efficient, dual clutch, six-speed transmissions. Initially, the award represented approximately $1.5 million in revenue in fiscal 2014, ramping to $10 million in fiscal 2016. We are very pleased to announce today that we've received additional volume from the OEM's [original equipment manufacturers] Chinese joint venture for approximately $0.5 million in revenue in fiscal 2014, but ramping to $10 million in fiscal 2016. This program now totals approximately $2 million in revenue in fiscal 2014, ramping to $20 million in fiscal 2016. We will begin producing these sensors for multiple platforms in the second half of fiscal 2014, and are currently in the design and development stage, working closely with the domestic OEM.

In our Power Products segment, we were awarded a program to provide an onboard, integrated polonium, which contains a 10-kilowatt charger and auxiliary for attainable power supply, and the associated vehicle interface controller for a pure electric commercial truck, being launched by a domestic OEM. Based on Eetrex's power electronic technology and know-how, and Methode's Automotive engineering and design for manufacturing expertise, the Eetrex Methode team work together from concept to production readiness. The $700,000 expense mentioned earlier was the cost of development of this product.

The production award represents approximately $2 million in revenue in fiscal 2012, ramping to $10 million in fiscal 2014. The technologies being developed by Eetrex and marketed and manufactured by Methode are synergistic and complementary to our Power Solutions portfolio. A number of our current customers have expressed interest in these power electronic systems, and represent an additional revenue pipeline for Methode as the push for alternative energy solutions expands. Speaking of Eetrex, I am also pleased to announce today that Methode has reached an agreement to make an additional investment in Eetrex of approximately $1 million, increasing our ownership to 51%. We also have the opportunity to take our investment to 90% at our option.

Finally, regarding the Hyundai Center Stack Program we discussed last quarter, which represented approximately $2 million in revenue in fiscal 2012, this award was for a mid-year short-lived program. Because of the time to design, develop and launch the Center Stacks, Hyundai elected to carry over the current design instead of using our Center Stack. Hyundai has indicated that they will potentially use our technology in a more prominent full-year launch in the future.

In summary, in this third quarter, Methode continued to demonstrate its capability of developing new technologies and more importantly, to use those technologies to bring products and solutions to our customers. Moving forward, we are pleased with our strategic progress and the growth opportunities that we see ahead.

Now I will turn the call over to Doug, who will provide further details regarding our financial results. Doug?

Douglas Koman

Thanks, Don. Good morning, everyone. Before I cover some of the more significant expense and benefit items that affected the quarter and nine-month period, let me walk you through the non-GAAP adjustments that we included in our earnings release.

For the third quarter, we reported net income of $5.9 million or $0.16 per share. This compares to a net loss of $4.5 million or $0.12 per share in last year's third quarter. In the current quarter, we reversed $1.7 million of the Blue Angel expense that we recorded in this year's second quarter. By excluding this benefit, third quarter net income would be reduced to $4.1 million or $0.11 per share. In last year's third quarter results, if we excluded the negative impact of $600,000 of restructuring charges, last year's third quarter net loss would've been reduced to $3.8 million or $0.11 loss per share. Therefore, on an adjusted non-GAAP basis, our net income was $4.1 million this quarter compared to a loss of $3.8 million in last year's quarter, or $0.11 earnings per share this quarter versus an $0.11 per share loss last year.

For the nine-month period, we reported net income of $9.4 million or $0.25 per share. This compares to a net loss of $2.4 million or $0.07 per share in last year's nine-month period. Excluding the $2.1 million expense for the Blue Angel matter and a negotiated program termination charge of $1.3 million that was recorded in the second quarter, the current nine-month period net income would have been $12.8 million or $0.34 per share.

If last year's results excluded the negative effect of $7.3 million of restructuring charges and the offset in favorable effect of reversing a $1.7 million one-time pricing accrual, last year's nine-month period would have been a net income of $3.4 million or $0.09 per share. Therefore, on a non-GAAP basis, the net income for the nine-month period was $12.8 million compared to $3.4 million last year or $0.34 per share this year compared to $0.09 per share last year.

Looking at our cost of products sold. In the current quarter, as a percentage of sales, our cost of products sold was 81.6% compared to 84.1% last year. This comparison would've been better except for a few unusual items. In the current quarter, we had a vendor supply issue on a new product launch that was about $1.3 million. We also had some manufacturing efficiencies at our multi-operation caused by multiple product launches that Don discussed earlier. While it's difficult to quantify the cost of these inefficiencies, we know that it did negatively affect our cost of goods sold in the quarter.

In the nine-month period, cost of products sold as a percentage of sales was 80.2% compared to 80.6% last year. As with the three-month period, the comparison would have been better except for the vendor supply issues, which were $2 million for the nine-month period, also, the negotiated program cancellation charge of $1.3 million, and a customer translation charge of $400,000 and additionally, the manufacturing efficiencies caused by the multiple product launches in the third quarter.

In selling and administrative, in the current quarter, as a percentage of sales, it was 15.3% compared to 19.2% last year. If the $1.7 million Blue Angel expense reversal were excluded, then selling and administrative would have been 17%, which is still below our 19.2% in last year's third quarter. It should be noted that this year's selling and administrative expense included $1.2 million higher stock award amortization, which was offset by lower Delphi legal expense of $1.2 million.

In the nine-month period, selling and administrative, as a percent of sales, were 17.4% compared to 17.8% last year. Here, if the Blue Angel net expense of the $2.1 million were excluded, selling and administrative as a percentage of sales would have been 15.7%, which is still below last year's 17.8%. This nine-month period selling and administrative expense included $1.2 million higher stock award amortization, partially offset by lower Delphi legal expense of $800,000 for the nine-month period.

As I mentioned before, a part of the increase in selling and administrative was the stock award amortization. Going forward, we expect this amortization to be higher. In October of 2010, the shareholders approved a five-year performance award for management. Last year's stock award amortization was low because the performance was granted over the past three years. It became worthless because of the restructuring and impairment charges taken over the last several years. So going forward, we expect the stock award amortization to be in the range of $800,000 and $900,000 per quarter.

If you look at operating cash, during the first nine months, we generated $19.6 million of cash from operating activities. While this was $3.7 million higher than last year, it does include a $13.1 million federal tax refund for a net operating loss carryback that was received in the third quarter. This offset net increase in working capital, that primarily resulted from the increased sales activities. Additionally, in order to protect the supply chain, we are also carrying higher inventory for certain components that have been in short supply in the market.

Just lastly, I want to comment on the credit facility. On February 25, we renewed our bank credit facility. The new facility, like the old, is for $75 million. It does have a five-year term, and the borrowing and commitment spreads are tiered based on our debt-to-EBITDA ratio, and at our current debt-to-EBITDA ratio fiscal result in lower spreads than the expiring facility.

Don, that concludes my remarks.

Donald Duda

Thank you, Doug. Christine, we are ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Jeremy Hellman with Divine Capital Markets.

Jeremy Hellman - Singular Research

Hi, good morning, everybody. A couple of things here. You guys laid out a lot of detail. There's not a lot that leads a lot to the imagination. But on the new power award, the integrated power unit that you were talking about that's with a nice sub, you said here, with Eetrex and Methode, you mentioned several hundred thousand of expense to date on that. Where do you see that total expense shaking out, firstly? And then kind of looking at your ability to go and take this to other OEMs, how replicable is it from a cost basis to go sell that elsewhere? Or do you have to go through kind of a full development spectrum to do that, I guess..

Donald Duda

That's a good question. Let me first answer the $700,000. We'll incur some additional cost, but I don't think they will be that notable. That expense is to really to develop the product line, such that we could take that charger to other OEMs, and present it to them. To our knowledge, it's one of the few 10-kilowatt chargers available. So we certainly have been speaking with others, and this first award was -- the first one is always the hardest one to get. So that helps greatly, and we have been talking with other OEMs. So it is very applicable to other opportunities.

Jeremy Hellman - Singular Research

Okay, great. And then secondly, for me, just some model details here just, because you had some things that work for and against you. In terms of the Auto segment gross margin, I think the vendor supply issue sounds like it was about 130 basis points or so in the quarter of a headwind. You mentioned that the inefficiencies involved, you can't really quantify. But kind of going forward, I guess, where my focus is, is that 18.5% to 19% still a reasonable basis to think about?

Donald Duda

Yes, I would say that, that's reasonable. And we said in the past, we're going to have chappy quarters. We're going to have some things that don't go our way. I think we're very good at launching products. But as I said in my prepared remarks, we've got a record number of launches, and we're going to have some issues from time to time. The one issue that we had, the larger one -- I hope we don't have another issue like that, but we're going to have some choppiness as we launch these programs and move to production, but the percentage is probably -- that's a good number.

Jeremy Hellman - Singular Research

And then last one for me, and I'll hop out. Just looking at the SG&A line, you had the 1.7 that was a one-time reversal. Stock comp you covered, and then the legal now drops out, if I'm correct. Is that right?

Douglas Koman

Yes. The legal was down in both the nine month and...

Jeremy Hellman - Singular Research

Okay. So that ought to get you to somewhere around $16 million or so as a quarterly run-rate level? Does that sound right to you guys?

Douglas Koman

Yes, you're talking about the quarter SG&A?

Jeremy Hellman - Singular Research

Yes.

Douglas Koman

Yes, that's about -- yes, that's probably a conservative number to use, $16 million, $16.5 million is conservative. We just have to bake in the long-term incentive program that we just talked about. So that would be comparing last year to this year. Going forward, that LTI [ph] amortization will be a little bit higher.

Operator

[Operator Instructions] Our next question comes from David Leiker with Robert W. Baird.

Joseph Vruwink

Hi, good morning. This is Joe Vruwink, on the line for David. Hey, Don, can you just go over the clutch sensor award one more time? I was a little slow in catching all the detail on the add-on portion of that contract.

Donald Duda

The award is for a 6-feet dual clutch transmission that the domestic OEM is having -- the transmission is being built domestically, and also in China via their joint venture. We're not at liberty to say who the OEM is, but it's a prominent domestic OEM. And we anticipated that they would first begin with the U.S. transmission and then ultimately would also be sourced in China. I can go through the numbers again for you. It starts out relatively slow at a couple of million per year and then by fiscal '16, I guess it's to $20 million. I just went back to that page. It's $2 million in '14, and then ramping to $20 million by '16.

Joseph Vruwink

And what was the original value with the...

Douglas Koman

The original was 1.5, but we didn't really add all that much in '14, but it doubled by '16. So it was originally 1.5 going to '10. Now it's 2 going to '20.

Joseph Vruwink

On these vendor supply costs, so with these cost, I guess it looks like you had about $600,000 last quarter and $1.3 million this quarter, and now you're saying that it's not going to be an issue going forward. Was the uptick in cost this quarter a result of actions Methode was taking to negate future costs, or what's a good way to think about this?

Douglas Koman

Uptick in cost in?

Joseph Vruwink

Well, uptick in the vendor supply costs, I believe, at the last part, you implied that they were $600,000. Now you're talking $1.3 million.

Douglas Koman

Yes, there was premium freight in there. There's overtime, so that all culminated in the third quarter.

Donald Duda

And at the end of the prior quarter, I don't think it was a full quarter. I think...

Douglas Koman

No, I agree.

Joseph Vruwink

I got it. With Automotive, Jeremy kind of touched on it, but even if you consider -- take out the positive reversal of the Blue Angel expense, and then offset that with the vendor supply cost, so just consider those netting out, you still did a 10% margin at the pretax line, which is pretty strong, considering you're still going through obvious manufacturing efficiencies. And I'm just wondering with the new business that you've launched in Automotive over the past year, as we get this Ford volume coming on, the transmission lead frame business. Is sort of this 10% level kind of structurally what we can expect, going forward, with the obvious give and takes with things that may happen in the supply chain, and as you launch these programs certain costs related to those?

Donald Duda

I would agree with that, except we're going to incur costs for launching the GM [General Motors] program. So I think you have to model that in a bit. That's the largest launch, I think, Methode has probably ever done. So we're going to have some costs to put that into production, but I think I would temper with that. On the gross margin line, though, I think we will stick with what we said in the past, it's the high teens.

Joseph Vruwink

Okay. And then did you pay down the amount you had outstanding on your prior revolver, that $18 million, I believe, you had out last quarter?

Douglas Koman

Yes. That was paid off at the end of the quarter.

Operator

Our next question is a follow-up question from Jeremy Hellman with Divine Capital Markets.

Jeremy Hellman - Singular Research

Just following up on your comment right there on the GM launch cost, just to make sure I'm kind of thinking about this correctly, where, I guess, when and how much do you see that becoming significant through the P&L? Is that going to kind of crescendo up into the 2013 period? Am I thinking about that right?

Donald Duda

I would use -- we're seeing about $100,000. My view is about $300,000 a quarter. It's not insignificant, but it's not -- it's noteworthy. It may increase slightly. So we ramp down our engineering quite a bit during the downturn.

Jeremy Hellman - Singular Research

Right, but that's all -- it's fairly levelized quarter-to-quarter?

Douglas Koman

Yes, with the said amount.

Donald Duda

Now, as we get closer to launch, you'll see some inventory increases and the normal stuff that occurs as you go through the launch, but we're a year away from returning on that closet.

Jeremy Hellman - Singular Research

Right, okay. The other one for me is more kind of longer term strategy oriented, just around the Power segment. Kind of looking at this topic we're talking about before with the power unit, can you give us any kind of perspective on what you see, if you want to call it addressable market or addressable opportunities? Certainly, $2 million in fiscal '12, going to $10 million in fiscal '14. I'm just trying to get a sense of how much -- whether that's just scratching the surface of what could be a nine-figure revenue opportunity or what. Just kind of some sense of that would be helpful.

Donald Duda

Let me make two comments. You've heard me say that the Power segment, I get fairly excited about that, because we're in a unique position in that we have been in high-current power apparatus for probably over 20 years. And we're also in the Automotive business, and you're seeing -- what's happening in the marketplace is the high-current systems are being used on hybrid and pure electric vehicles. And we're in somewhat of a unique position, as we have our Automotive manufacturing pedigree. So there's a lot of companies that can provide onboard chargers and power management systems, but not that many that have Methode's credentials in power, so that are in manufacturing and Automotive. So that puts us, I think, in a nice position. Now trying to peg the market, even look at any market study on electric vehicles, and so how long do you see a hockey-stick type ramp, so it's hard to peg that. I'm not really happy with the price of gas and oil, but it does tend to push more companies towards the alternative fuel vehicles. So, Jeremy, it is really hard to say. I mean, I've read one report, where if we just took a small percentage of that market, we'd have a huge business. The quick answer is I think it's probably too soon to tell. We do know that these programs are in the $5 million to $10 million, $15 million range. So if you pick off $3 million, $4 million, $5 million of those, that makes for a nice business. And the technology is what we developed, and we spent some money on is applicable to other customers. So we're excited about it, but it's hard to peg a number.

Jeremy Hellman - Singular Research

Right. Well, maybe one way of looking at it from my end, is this a situation where they come to you completely, and I guess the question is how proactive are you or can you be in kind of like showing them kind of what's out there and what they can do from a product solution perspective?

Donald Duda

And that is why we wanted to an alliance with Eetrex, because it's Eetrex that has the engineering capability or the reputation, [indiscernible], but they are known in the marketplace. So linking up with a company like Methode allows our customers to -- okay, I can get this technology, and I can get it manufactured by a pro, so I guess, through their own hardware [ph], but that's a nice combination. So Eetrex does have people that come to them, but we're also being very proactive. Now that we have a charger and probably, it's really at the prototype or the P&D [Prototype & Design] stage. We are laying it out and talking to other accounts. So it's a combination of both.

Operator

Mr. Duda, there are no further questions at this time. I would now like to turn the floor back to you for closing comments.

Donald Duda

Thank you, Christine. We will wish everyone a very good day, and thank you for calling in. Good day.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Methode Electronics' CEO Discusses Q3 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts