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Methode Electronics (NYSE:MEI)

Q3 2012 Earnings Call

March 01, 2012 11:00 am ET

Executives

Donald W. Duda - Chief Executive Officer, President and Director

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

Analysts

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Operator

Welcome to the Methode Electronics' Fiscal 2012 Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

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 report. Such factors may include without limitations, the following: dependence on a small number of large customers, including 2 large automotive customers; dependence on the automotive, appliance, computer and communications industries; further downturns in the automotive industry or the bankruptcy of certain automotive customers; ability to compete effectively; customary risks related to conducting global operations; dependence on the availability and price of raw materials; dependence on our supply chain; ability to keep pace with rapid technological changes; ability to avoid design or manufacturing defects; ability to protect our intellectual property; ability to withstand price pressure; the usage of a significant amount of our cash and resources to launch new North American automotive programs; location of a significant amount of cash outside of the U.S.; currency fluctuations; ability to successfully benefit from acquisitions and divestitures; ability to withstand business interruptions; unfavorable tax laws; ability to implement and profit from newly acquired technology; and the future trading price of our stock.

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

Donald W. Duda

Thank you, Louis, and good morning, everyone. Thank you for joining us today for our fiscal 2012 third quarter financial results conference call. I am joined today by Doug Koman, Chief Financial Officer; and Ron Tsoumas, Controller. Both Doug and I have comments, and afterwards, we will be pleased to take your questions.

On a consolidated basis, net sales grew nearly 10% in both the third quarter and first 9 months of fiscal 2012 compared to the same periods last year. The sales improvement was driven primarily by new product introductions and higher market penetration in our North American and Asian automotive business units. Sales gains were partially offset by declines in our Interconnect segment, a direct result of continued softness in the appliance market and the sale of our Optical business in the fourth quarter of last fiscal year.

We posted third quarter net income of $0.8 million or $0.02 per share compared to $5.9 million or $0.16 per share in the same quarter of last year. For the first 9 months of fiscal 2012, we had net income of $2.6 million or $0.07 per share compared to $9.4 million or $0.25 per share in the comparable period last year. For both periods of fiscal 2012, net income was negatively impacted by higher foreign income taxes. Additionally, the settlement of the Blue Angel dispute in the second quarter of fiscal 2011 skewed the year-over-year net income comparison in both the third quarter and first 9 month periods. Excluding the benefit for settlement of the Blue Angel dispute of $1.7 million in the fiscal 2011 period, Methode's net income was $4.1 million or $0.11 per share in last year's fiscal third quarter.

As in the last several quarters, design, development and launch costs in both our Automotive and Power Products segments continued to impact net income and gross margins. Additionally, vendor production and delivery issues and increased sales of products with higher prime cost further affected our North American automotive income. In total, the development and launch costs and vendor charges lowered our third quarter net income by approximately $3 million or $0.08 per share and lowered our gross margins by 2.7 percentage points. In the 9-month comparison, these costs and charges lowered net income by $6 million or $0.16 per share and lowered our gross margins by 1.8 percentage points.

While vendor production and delivery issues for the Ford Center Console Program impacted the first 9 months of fiscal 2012 by $3.1 million. The vertical integration project is on track which will alleviate this issue. That being said, we anticipate the vendor production and delivery issues will impact net income by approximately $0.6 million in the fourth quarter of fiscal 2012. Additionally, our Ford Center Console Program currently carries a higher prime cost due to the higher purchase content which reduced the program's overall gross margins. This should also be mitigated by the vertical integration.

We also incurred costs related to the design, development and launch of the General Motors Center Console Program. Thus far, in fiscal 2012, we have incurred $2.9 million for this program and anticipate another $1.3 million in the fourth quarter of this fiscal year and approximately $4.5 million in fiscal 2013 in total launch costs. These costs will also be absorbed as the product launches and revenue is realized. The majority of those costs being the first 2 quarters of fiscal 2013. While these costs are having an impact on our results now, this program which launches in the fourth quarter of fiscal 2013 has total anticipated revenue well in excess of $0.5 billion over the life of the program.

To update you on the General Motors award. We can confirm that the center consoles will be used in our next generation truck platform. Our content on the product and the anticipated volumes have been increased by the OEM. As such, we've also increased our engineering spend on this program which is reflected in the $1.3 million and $4.5 million estimates just discussed.

Finally, in our Power Products segment, development costs for the Eetrex on board integrated power unit were approximately $0.6 million in the third quarter and $1.8 million in the 9-month period. We estimate development costs of $0.6 million in the fiscal 2012 fourth quarter and similar expenses throughout fiscal 2013. This investment will result in a suite of products applicable to a wide variety of applications for not only e-vans [ph] but also stationary power systems. Specific to the current e-van [ph] customer we have discussed in the past, we have significantly reduced our revenue expectations for this program for fiscal 2014, which was originally $10 million, as a result of our customer's reengineering their product.

Turning to our review of our individual segments. In the third quarter, Automotive segment net sales increased almost 24% and in the first 9 months improved over 23% due to higher sales from the Ford Center Console Program as well as from our transmission lead-frame and steering angle sensor products. The acquisition of Advanced Molding and Decoration, AMD, contributed almost 54% of the North American automotive sales increase in the third quarter and 36% in the first 9 months. Automotive segment gross margins decreased in the third quarter and 9-month comparison, impacted by the vendor issue, the higher prime costs for the Ford center console and costs related to launch of the GM program. Again, our target gross margins for automotive are low- to mid-20s which we anticipate reaching once the General Motors Center Console Program is fully launched in the first quarter of fiscal 2014.

Interconnect sales decreased approximately 10% in both the third quarter and 9-month comparisons attributable mainly to lower appliance sales in North America, as well as the sale of Optokon in April of last year. These lower sales were partially offset by increased sales of data and safety remote control products. As we mentioned last quarter, we anticipate reduced appliance sales will continue through fiscal 2012 and the first quarter of fiscal 2013. Interconnect's gross margin fell in the second quarter and first 9 months, again due to lower sales.

Our Power Products segment saw flat sales in the third quarter but improved sales of 8.5% in the first 9 months. Power Products gross margins decreased in both reporting periods mainly due to product mix and the Eetrex product development costs. Without the new product development costs, gross margins would have been 21.5% in the third quarter and 30.8% in the first 9 months. Our target gross margin for the segment is in the high 20s.

Now moving to what we see for the several next quarters. As we have said before, we see opportunity through meaningful improvement in our margins once the vertical integration project is complete and we reach full launch of major programs in fiscal 2014, where we are poised to exceed Methode's 2008 historical revenue high of $551 million. If you recall, we laid out for you on last quarter's conference call the major programs which are anticipated to achieve approximately $630 million in fiscal 2014 revenue.

Now let me summarize some of the design wins and business awards we have not yet announced. In the third quarter, we booked a number of programs in our Automotive segment for hidden and ergonomic switches to be manufactured at our European facility that have an average annual revenue of over $10 million beginning in fiscal 2016, with a program life of 5 years. These programs exemplify our continued penetration of the European automotive market.

In Interconnect, TouchSensor has been awarded for the touch user interface on a laundry platform for a large appliance OEM. The platform which launches this summer will be used on multiple major brands and represents $30 million to $40 million in annual revenue at full run rate. This award is TouchSensor's first major volume win in the laundry space and demonstrates that touch technology continues to grow in popularity in the white goods segment. This award has been included in our revenue projections and in our guidance.

In the near-term, our fourth quarter of fiscal 2012 should be our strongest of the year due mainly to the launch of the Ford e-car program as well as the launches in Europe.

We maintain our 2012 full year guidance of $450 million to $465 million in sales and earnings per share of $0.13 to $0.21. In fiscal 2013, we anticipate $495 million to $525 million in sales and earnings per share of $0.52 to $0.67, driven by our base business along with the major awards we have previously discussed.

That said, we anticipate our revenue ramp, again from booked programs not projections, will occur at the end of the fiscal 2013 second quarter. As such, the first and second quarter of fiscal 2013 will be impacted by significant launch costs.

In summary, we continue to move closer to the launch of several large programs, which, combined with our vertical integration projects, not only lead to improved revenue, but also to margin improvement.

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

Douglas A. Koman

Thanks, Don. Good morning, everyone. I'm going to keep my comments very limited today since we provided a lot of detailed information on the third quarter and 9-month period in both our earnings and 10-Q.

So let me start with the effective tax rate. The effective tax rate was 60% in the third quarter and 58% for the 9-month period. This high rate with this is primarily due to the fact that we generate most of our taxable income in China where the tax rate has been 12.5% and just increased 25% effective January 1, 2012. Another item that negatively affected the effective tax rate for the 9-month period was the fact that we had $900,000 of withholding tax expense and that was on the dividend that we declared from our China facility to our Singapore facility of about $17 million. We did that, if you recall, to reduce the amount of cash concentrated in China. As we look forward to the fourth quarter, we expect the consolidated effective tax rate to reduce significantly and this is as we begin to see offsetting taxable income growth in both the U.S. and Malta, where we benefit from both net operating loss carry forwards and investment tax credit carry forwards respectively in both of those locations.

I'll take a look at the capital expenditures. For the 9-month period, we spent $16.6 million in CapEx. In addition to that, we spent $6.3 million for the acquisition of the business assets of the former Nypro operation in Monterrey, Mexico. This acquisition actually allowed us to save about $8 million of equivalent greenfield capital expenditures for new equipment that would have been needed to bring the molding, paint and laser-etch process in house. We expect to spend an additional $7 million to $8 million in the fourth quarter primarily related to the molding, paint and laser-etch process. For fiscal 2013, we expect CapEx to be between $15 million to $17 million, which is in line with our historical CapEx spending rate.

Looking at currency exchange, during the 9-month period, we recorded net foreign exchange losses of $800,000. This is due to the appreciation of the renminbi to the U.S. dollar. The remainder of the currency pairings that we have primarily the U.S. dollar to the euro actually resulted in gains for the 9-month period. And management is considering hedging alternatives to mitigate the exposure to the renminbi going forward.

On the credit facility, we increased our borrowings in the third quarter by $3 million to $39.5 million from $36.5 million. Currently, most of our cash is located outside the United States. While we eventually expect to generate cash in the U.S. primarily through future domestic operations. It will be necessary to continue to borrow from our foreign affiliates and under the credit facility for the near term. Management has engaged consultants to review efficient opportunities to repatriate cash back to the United States.

Finally, on operating cash. During the 9-month period, we generated $11.9 million of cash from operating activities. However, this was $7.7 million less than last year primarily due to the lower net income. We also have higher stock award amortization this year of $1.2 million and we saw about $1.3 million of unfavorable change in working capital.

If you look at the cash balance, net of borrowings during the 9-month period, we burned about $20.1 million. This was primarily due to the lower net income, also the $16.6 million of capital expenditures and $7.8 million in dividends and the $6.3 million for the acquisition of the Nypro assets. We expect the situation to reverse as we launch the new automotive and appliance programs.

Don, that concludes my remarks.

Donald W. Duda

Doug, thank you very much. Louis we are ready to take questions.

Question-and-Answer Session

Operator

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

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

This is Joe Vruwink for David. Just -- can you maybe provide clarification on the Interconnect award for appliances. It sounds like a great award with a customer you've been trying to get more involved with. Do you have a idea when you might hit full volume or a good annualized rate of volume on that program?

Donald W. Duda

I can't provide really too much more background on the award. I can say it will begin its launch in late summer and hit its stride in the next calendar year.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Okay. And is that $30 million to $40 million on today's kind of level of appliance demand? So if we would theoretically get a recovery in the housing markets, you're looking at a lot more than that $30 million to $40 million?

Douglas A. Koman

I think I would say on the low end of that $30 million is we're kind of saying status quo, and then on the higher end, the $40 million is some recovery in the market. Not, I wouldn't say, back to the '08 level but I think we've taken that into account in the $30 million to $40 million.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then on the Power, or it's the Eetrex award, did you provide what's -- it's not $10 million anymore, but did you say what it actually is now?

Douglas A. Koman

We have not. The customer is rethinking their product and we just wanted to let everyone know that we've reduced that significantly in our projections. So I don't think I want to say yet, because it could be, could be nothing, could be several million.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

And then the thought process -- it sounds like you're still going to go ahead with $2 million or $2.5 million of Eetrex investments next year. Maybe just give an explanation on the thought processes of the revenue opportunity for that product is maybe diminished in the next, well, near term, I guess?

Donald W. Duda

Potentially from an e-van [ph] standpoint, but from stationary power that, that is probably increasing our optimism for the revenue gain in Eetrex. As you know, we have a data center business and lithium-ion technology is starting to be deployed in the data centers, moving away from lead acid. So the combination of Eetrex and our path to market with our data center business provides some pretty good near-term opportunity. And, again, not diminish e-van [ph]. It's just our one customer is changing their product strategy a bit. And so that caused us to reduce our expectations there. But I think our expectations for the other markets are quite high.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Okay. Great. And then just on the Q4 I know you don't give quarterly guidance, so you can back in on that it's going to be, I guess, $0.06 to $0.14. Are there swing factors that you see on the horizon that could still feasibly get you to the $0.14 figure? And I'm wondering what those are?

Douglas A. Koman

The reason we didn't change the guidance is the company's position is that we provide annual guidance. So we're not going to try to narrow the range. But there are -- we talked about taxes before, taxes can swing quite a bit. And that's one of the items that can be driving that number possibly up to the higher end of that range but that's primarily why we've left the guidance where it's at. It's that management report [ph], just the business of providing annual guidance at this point.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Is there anything that would cause for a tax benefit in Q4?

Douglas A. Koman

Yes. When we -- in the fourth quarter, what we'll do is we'll finish our budgeting process and that's when we take a look at a lot of our valuation allowances in the -- on the tax side. And there -- I think there could be some movement there.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then just one last tax question. Have you been planning for a certain effective tax rate? I mean, you're -- I guess you're coming in -- would [ph] be under that so you have to play catch-up in Q4 and that's what would contribute to maybe lower than expected taxes? If I'm thinking about that correctly?

Douglas A. Koman

Yes. And it's really the lower -- the expected lower effective tax rate in the fourth quarter is going to be because we're going to start generating more income in both Malta and the U.S. that are sheltered by -- again, in U.S. we have the net operating losses. In Malta, we have the investment tax credit offsets. So what happened is the, as we generate more non-China income that just lowers the effective tax rate, even though the China rate is going up. It becomes a smaller part of the pie. So that's what's going to drive the lower rate in the fourth quarter. And like I said, it will also be the reason that next year we expect a lower tax rate.

Joseph D. Vruwink - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then I actually, I had a one more question. On the pick ups in the GM business on the new T900 platform. Is there any -- can you provide maybe models? Or can you clarify, I'm guessing, it's going to be on the SUVs or crossovers, can you provide maybe any further granularity on that?

Donald W. Duda

Not at this time. But -- all I -- all we can do is what I put in our prepared remarks. I'm sorry.

Operator

[Operator Instructions] Mr. Duda there are no further questions at this time. I would like to turn the call back over to you for closing comments.

Donald W. Duda

Well, thank you, Louis. We'll thank everyone for listening and wish everyone a good day. Thank you.

Operator

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

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