Methode Electronics, Inc. (MEI) CEO Don Duda on Q1 2019 Results - Earnings Call Transcript

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About: Methode Electronics, Inc. (MEI)
by: SA Transcripts

Methode Electronics, Inc. (NYSE:MEI) Q1 2019 Earnings Conference Call August 30, 2018 11:00 AM ET

Executives

Don Duda - Chief Executive Officer

Ron Tsoumas - Chief Financial Officer

Analysts

David Leiker - Robert W. Baird

Chris Van Horn - FBR

Operator

Welcome to the Methode Electronics Fiscal Year 2019 First Quarter Earnings Conference Call. 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 forward-looking statements, which reflects management's expectations regarding future events and operating performance and speak only as of the date hereof. These forward-looking statements are subject to a Safe Harbor protection provided under the securities laws. Methode undertakes no duty to update any forward-looking statements to conform the statements to actual results or changes in Methode's expectations on a quarterly basis or otherwise.

Forward-looking statements in this conference call involve a number of risks and uncertainties. The factors that cause these 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 limitation, the following, dependence on a small number of large customers, including two large automotive customers, dependence on the automotive, appliance, computer and communication industries, investment in programs prior to the recognition of revenue, timing quality and cost of new program launches, uncertainties surrounding the completion and success of the Grakon acquisition, ability to withstand price pressure, including pricing reductions, currency fluctuations, customary risks related to conducting global operations, changes in U.S. trade policy, ability to successfully market and sell Dabir Surfaces, dependence on our supply chain, income tax rate fluctuations, dependence on the availability and price of raw materials, fluctuations in our gross margins, ability to withstand business interruptions, ability to keep pace with rapid technological changes, breach of our information technology systems, ability to avoid design or manufacturing defects, ability to compete effectively, ability to protect our intellectual property, successfully benefit from acquisitions and divestitures, recognition of goodwill impairment charges, success of Pacific Insight and Procoplast and/or our ability to implement and profit from new applications of the acquired technology, significant adjustments to expense based on the probability of meeting certain performance levels in our long-term incentive plan and costs and expenses due to regulations regarding conflict minerals.

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

Don Duda

Thank you for joining us today for our fiscal 2019 first quarter financial results conference call. I am joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I have comments and afterwards, we will take your questions.

Year-over-year fiscal 2019 first quarter sales increased 11% to $223.4 million and earnings per share increased from $0.55 to $0.63. First quarter earnings benefitted from higher sales in the Automotive and Power Product segments, decreased stock award amortization and acquisition related expenses, lower legal fees, and a favorable currency impact from the weakening of Mexican peso.

First quarter earnings were negatively impacted by selling and administrative expenses and increased intangible asset amortization expense, both attributable to the fiscal 2018 acquisitions and customer price reductions. Compared to last year, consolidated gross margins decreased 70 basis points in the first quarter to 26.9%, negatively impacted by sales mix in the Automotive segment related to the fiscal 2018 acquisitions and price reductions. This will substantially offset by a favorable mix in the interface segment and higher sales volume in the Power Product segment as well as a favorable currency impact.

Year-over-year fiscal 2019 first quarter selling and administrative expenses decreased due primarily to lower acquisition related stock award amortization expenses. This was partially offset by selling and administrative expenses from the fiscal 2018 acquisitions which did not occur in last year's first quarter. Year-over-year fiscal 2019 first quarter pretax income was $28.2 million compared to $24.8 million First quarter operating margin was 12.9% this year compared to 12.6% last year.

Moving on to review of our segments. Year-over-year Automotive segment sales increased 12% in first quarter due to sales from the Procoplast and Pacific Insight acquisitions, and increased hidden switch sensor and human machine interface product volumes. The improvements were partially offset by lower volume and price reductions of center consoles and transmission lead-frame assemblies and decrease during angle sensor sales. Year-over-year, automotive gross margins decline 250 basis points to 26.8% in the first quarter due to sales mix related to the fiscal 2018 acquisitions and price reductions, partially mitigated by a favorable currency impact.

Moving to Interface. Year-over-year segment sales decreased 1.4% in the first quarter driven mainly by lower client sales and the exit of connectivity which contributes $700,000 in sales in the first quarter of last year. These decreases were substantially offset by improved radio remote control sales. Compared to last year, Interfaces gross margins increased 440 basis points to 26.2% in the first quarter due to improved radio remote control sales and a favorable product mix.

First quarter Hetronic litigation costs were just under a $1 million this fiscal year versus $2.9 million last year. We anticipate litigation cost to be $4 million to $5 million for fiscal 2019 and we currently anticipate litigation ending at fiscal 2019.

In our Power Product segment, sales increase year-over-year by 23.7% in the first order due to higher PowerRail and busbar sales in North America and Asia. Year-over-year segment gross margins in the first quarter increased 220 basis points to 29.8% primarily due to higher sales. As we announced 10 days ago, Methode has agreed to acquire Grakon, a global leader in the design, development and manufacturer of ventilating systems, controls and components for premier OEM manufacturers and the heavy truck, bus, rail, power sports and electric vehicle markets.

Grakon sales teams have shared the news with their customers, many of whom are interested in Grakon's ability to bring additional technologies and more complex integrated solutions through the acquisition. The news has also been received very positively by both Methode and Grakon employees who are excited to learn more about Methode capabilities and ways to leverage our complementary markets and growth opportunities. Both teams believe our companies fit very well together with cultures focused on delivering high quality products, engineering solutions and growth through innovation.

We expect the acquisition close in September, subject to Hart-Scott-Rodino and customary closing conditions. We'll update fiscal 2019 guidance based on the acquisition when the third-party evaluation is finalized. A further analysis of projected income is complete and transaction costs are settled. However, as we announced in the release this morning, we are reaffirming full year's guidance exclusive of the transaction and related costs in financial results of the Grakon acquisition. The guidance ranges from fiscal 2019 are based upon management's expectations regarding variety of factors and involve a number of risks and uncertainties which have been detailed in this morning's release and Form 10-K.

Before moving on to new business, I'd like to provide some insight as to our outlook on our North American automotive business. As a reminder, our full year revenue for North American automotive exclusive of Pacific Insight is projected to be lower this year over last year by up 6%, impacted by the price reductions of approximately $14 million in purchase delays, which I discussed in previous calls, lower volumes of lead frames and certain integrated center consoles as well as contractual price concessions.

For the first quarter, revenue for North American auto exclusive of Pacific Insight was down about 10.5% over last year's first quarter, also impacted by the changeover of major platform by our largest customer. However, we do have significant amount of previously announced new business that will launch very late in this fiscal 2019 and early fiscal 2020 including four overhead console programs and integrated tailgate mounted program, all new organic products for a total of approximately $21 million in revenue in fiscal 2020.

As far as new business in the first quarter, North American automotive was awarded the overhead console for the next generation Ford Bronco SUV program with the program life of seven years, annual revenues of approximately $3.8 million beginning mid-fiscal 2021. There were also awarded a door activation switch program for Ford. The door handles replaced by an activation switch and the driver's phone replaced with the keypad. As the driver approaches the vehicle, the phone unlocks the door.

With the program life of six years, average annual revenue was approximately $2.3 million beginning in fiscal 2021. European Automotive was awarded their first electric vehicle program with Volkswagen to supply battery connection busbars and power distribution modules utilizing complex insert-mold technology for the OEM's new electric vehicle platform.

With the average revenue of $8 million for four years, the program launches in fiscal 2020, also the Europe was awarded an additional HVAC control panel with Renault for their commercial vehicles. This program represents $6.5 million in average annual revenue beginning fiscal 2021 for 5 years.

Finally, McLaren awarded European Automotive, the complete set of interior switches as well as an innovative and stylish touch screen and information displays for two new programs with average annual revenue of $2.5 million for four years beginning fiscal 2021. Asia Automotive was awarded a 4 year program with Great Wall Motors for touch screen assembly for $23 million in average annual revenue launching in fiscal 2021. In total, these awards represent $38 million on organic growth beginning in fiscal 2021.

Now, let's move on with an update on Dabir. During the first quarter, we saw the continued expansion of the Dabir Surfaces within several of our current hospital sites at Beaumont Health Network in Detroit, we expanded some of the cardiovascular OR and electrical physiologies lab to the surgical ICU. At Porter Hospital in Denver, we added the cardiovascular OR to the head and neck surgical OR. Cleveland Clinic extended their adoption of Dabir from the cardiovascular and transplant OR to neuro and plastic surgery.

Lastly, Loma Lindy University Medical Center near Los Angeles which began their adoption of Dabir in the OR expanded the utilization to post op recovery. We also added three new customers. Aurora St. Luke's South Shore in Milwaukee has adopted Dabir for neurosurgery. Alberta Health Services in Edmonton Canada, our first win in that market has adopted Dabir for Neuro Surgery while Parkview Health in Fort Wayne, Indiana has adopted Dabir for all 14 of their ORs.

Additionally, we successfully completed evaluations at six hospital sites and began clinical evaluations at six additional hospitals. These evaluations are required at each hospital -- at each hospital prior to adoption of Dabir to demonstrate product efficacy and their particular application.

Moreover, we are now engaged with several group purchasing organizations or GPOs as hospital typically require new vendors to use our existing GPO relationship for procurement and contracts. Earlier in the quarter, the Dabir sponsored peer review supplement to American Nurses today titled pressure injuries prevention across the acute care continuum was published and distributed to over 200,000 subscribers. The publication has very good reviews and generates significant leads for our teams to pursue.

Now, I will turn the call over to Ron who will give further details regarding our financial results.

Ron Tsoumas

Thank you, Don. Good morning everyone. I have a few brief comments on the quarter. Before I begin my commentary, I want to clarify that my comments do not include the impact of the acquisition of Grakon. As Don mentioned in his prepared comments, the Company will incorporate Grakon into its guidance after the third-party evaluation is finalized, the analysis of the projected income is complete and transaction related costs are settled.

For the first quarter, the Company reported an effective tax rate of 16%. This was primarily driven by the composition of the pretax income in regions with lower effective tax rates and the full benefit of lower rates in the U.S. due to tax reform, partially offset by some more favorable discrete adjustments in the fiscal 2018 period.

The final impacts of tax reform may differ from the amounts estimated, due to among other things, changes in interpretation of tax reform and legislative guidance. The Company currently anticipates finalizing and recording any resulting adjustments within the one year allotted re-measurement period, which will occur in our third quarter of fiscal '19. We anticipate that our effective tax rate will normalize for fiscal year 2019 and estimate it to be in the range of 16% to 18%.

Turning our attention to SG&A, you will note that in the first quarter SG&A, inclusive of intangible amortization, as a percentage of sales was 14% compared to 15% in the prior year, resulting in a decrease of $1.1 million. During the quarter, selling and administrative costs, excluding intangible amortization decreased to $100,000. However, the first quarter of this year included $3.6 million of costs associated with the Pacific Insight and Procoplast acquisitions.

Absent these costs, selling and administrative costs decreased $3.7 million due to lower acquisition related and stock award amortization and lower legal fees. Partially offset by increased expenses for outside consulting fees, travel, wages and benefits. Amortization of intangibles increased $1.2 million due to the amortization expense related to Pacific insight and Procoplast acquisition, neither of which were included in the first quarter results of fiscal 2018.

Moving on to capital expenditures, in fiscal '19 first quarter, we invested $18.2 million in the business mainly to support programs and launches in North America and Europe. We are estimating capital investment in fiscal '19 to be in the $52 million to $58 million range. Depreciation and amortization expense for the first quarter was $8.4 million. For fiscal 2019, we expect full year depreciation and amortization to be between $34 million and $36 million.

Shifting to EBITDA, the Company generated $36.8 million in the quarter or 16.5% of sales. For fiscal 2019, we expect EBITDA to be between $161 million and $170 million or in the 16.5% to 17.5% of sales range. Free cash flow for the first quarter was $13.9 million. We expect fiscal '19 free cash flow to be between $85 million and $90 million.

Don that concludes my comments.

Don Duda

Ron, thank you very much. Rhonda we are ready to take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of David Leiker with Robert W. Baird.

David Leiker

Let's see where do I want to start. The automotive contract awards, I guess a couple of things that we could find a way of kind of roll this together, but it looks like the pace of new contract awards are winning and the breadth of the customer and products is happening. Is this something in that ramp up? I mean I guess the question is, how sustainable is kind of that trajectory and this broadening customer product mix in terms of launches or that contract awards?

Don Duda

It's always hard to predict from quarter-to-quarter what the awards are going to be. And as you know we tend to buck them in 75% probability, 50% inorganic and 70% to 75% sometimes all the way side and you find something in your embryonic that takes its place. So, that's hard to predict, but we have deliberately moved into overhead consoles, so we're talking about four wins there. And they're not center consoles average sale price, but also don't have displays. So, we deliberately did that.

We're very pleased with what we've seen in electrical vehicle particularly award on Volkswagen and that really says that we are a global supplier of products to EV. Some of the wins we've got with Renault can continue, but it is very hard to predict. But center consoles which now they've been around for quite a while are on a second major program. And there is price pressures there so we've branched out so where we think we can sustain our margins.

David Leiker

And then within that context, it seems like they are doing a great job of taking the existing --almost seems like you got a product and that's kind of an anchor with that customer and then cross sale different technologies into that same customer. That seems to be accelerating as well. Is that the right way to look at that?

Don Duda

If you're talking about anchor product being center consoles?

David Leiker

Well, I mean in center consoles but in some cases there might be something different like a busbar?

Don Duda

Yes, that's our base strategy is to bring our technology to our customers and help them make their products better, saving money, solve a problem, that's really our core strategy and then that does work.

David Leiker

And then the opposite, go ahead, sorry…

Don Duda

No, we're just we're pleased that we're seeing that. I was also very pleased to announce touch screen in Asia with the Great Wall. That's a nice win for our Asian group.

David Leiker

Yes, that is -- I agree that is nice. And on the opposite side of this then, what's the pace of contracts going and the license rolling off on the back end? Is that a fairly stable number then next year or two? Or is there some changes in the way that that closed?

Don Duda

We're going to see our steering angle sensor go into life in Asia, not this year but next year. Last quarter I commented on our lead frame business. That has always had peaks and valleys, but now we've seen several quarters of decline there and that T76 transmission were Tier 2 to Continental that four pass cars. At this point, we see that being down in the 20% range. And that's not scheduled to go end of license. So I think 24, but it is pass car. So we have to take that number.

David Leiker

Okay, I'm going to sneak one more in here. Similar kind of question on the on non-automotive side, I mean if you look at that pool of assets that you have, the revenues are generating outside automotive business that's also accelerating. How much of that is structural and repeatable and how much of that might be timing or mix related issues?

Don Duda

Let me talk about power first. It's hard to predict that business. We've seen some great quarters. And then we've seen them because maybe [indiscernible] spending down or our big data customers slowing down on their spanning capacity and cloud computing. So it's hard to predict that we're going forward for the duration of this year, we feel very confident. And that we've also taken costs out of that business. And so, the margins have improved nicely. Volume also helps in that business, it gets to a certain point and it has very good point in sales that has very good flow through from that.

Hetronic, obviously, we spend a lot of money defending that business. And we did that for a particular reason. And we want to protect that, that channel to market and we've done that and that we're seeing the results of again, some structural changes of Hetronic, we now produce both in Monterrey, Mexico and in Egypt. So, it's taken cost out, we've taken lead times out of all the stuff that Methode does very well. And they're kind of the people to beat in that market right now. Plus, with the acquisition of Grakon, we feel -- we can bring some Grakon products to their customer base. So for example Manitowoc Cranes that might be -- I am just picking in customer. So, we do believe it's sustainable with the caveat that busbar can be a little spiky.

Operator

Thank you. [Operator Instructions] Our next question comes from line of Chris Van Horn with FBR.

Chris Horn

Just to kind of continue on the path of these new awards. Any additional details, one of my questions was on the door activation switch. Is that just one program? Or is that going to be across the fleet for that customer? And then, is this your first overhead win with Ford?

Don Duda

Let me answer the second question first, no it's not. But on the door activation switch, we can't speak for the customer, but we hope they carry it over other platforms of course, but it is one award and we'll have to see what will happen. That's the question you got to ask our customer.

Chris Horn

Okay got it. The initial award is just for one program. Is that correct?

Don Duda

Correct.

Chris Horn

Okay, got it. And then the EV win with VW, is that similar to the work you're doing with Tesla similar product line?

Don Duda

Yes, I mean each OEM has their own particular battery design, but that's essentially at an end. There is a distribution module. It's -- loosely you can call it a lead frame. It's complex insert molding which we do very well, so it's a combination of the two. That -- we're very pleased with that win.

Chris Horn

Okay. Yes right. Obviously expands that EV opportunity. And then the China win I think was really impressive. And what's kind of your domestic China exposure now? And then what does this kind of do to that?

Don Duda

This is I'm going for memory, but I'm fairly sure this is a largest award we received from a domestic OEM in China. Great Wall has been the good customer. We had a good relationship with them. So, our exposure is really with Great Wall. We have some other smaller business with some of the other OEMs but it's really Great Wall. And then of course we do business with GM and Ford and others, which has then the majority of our call it domestic Chinese businesses. Now with Great Wall that kind of starts to turn at the other way. So we're very pleased with that one.

Chris Horn

Okay great. Thanks for the additional color on that. Moving over to margins, how do we think about margin cadence for the rest of this year as you kind of get Procoplast and Pacific Insights more into the Methode margin profile? And then I apologize if I missed it. But did you ever give any sort of Grakon synergy opportunities that you see there?

Don Duda

Again, let me answer the second one first. No, we haven't given anything on synergies yet. We need to operate the Company. And we know there is synergies and there is, no. The synergies and products I mentioned about that with David's question on Hetronic. We also know that as we institute the Methode manufacturing system there's costs that we can take out of the factory and cost of quality and leading out the fact. They were in a good factory this is not a, we're an automotive supplier, so we're implement our Methode manufacturing systems. There are still these things that we will talk about. We just we haven't operated it at this point.

Chris Horn

And if you don't mind, just kind of how we think about the margins and getting Procoplast into…

Don Duda

Pacific Insight and Procoplast, really the margin improvement is really at 2020 event. Something at the end of the year, but it's really more 2020. And I would say the same on Grakon. That's not something that we're going to come out of the box and immediately improve. That's probably more of a '22 event when you -- when you think about it. So, it's about and back then 18 months, before we see. And we, we're cautious, we don't want to go and screw something up either so. So we've kind of take stock of where we are and before we start implementing anything.

Chris Horn

Okay, got it. And then last one for me, I'll jump back in the queue. The radio remote control business just continues to perform very well. Any specifics going on their new customers, new wins or just continued business with existing customers, what's the dynamic there?

Don Duda

I have all of the above there, there are new customers that reduce their lead time and that's something we do across the board in our non-automotive businesses that we want them to improve their lead time. So if their lead time was six weeks, we want to get down to two weeks. Because generally the customer is not as concerned about the price obviously if you're doubling the price you have an issue, but we have price, you get the business.

And we've seen that in and we've implement that and Hetronic team has done an excellent job of getting their lead times down. But we've also introduced new products, different styles of remote controls. We've upgraded the display. So, there is a number of things that we've done that has taken us a couple years to get there to improve the product offering which has improved the business.

Operator

Thank you. We reach the end of our question-and-answer session. I would like to turn the floor back to management for closing comments.

Don Duda

Rhonda, thank you very much and thank everybody for listening and the questions today. And wish everyone a very safe Labor Day holiday. Good bye.