Methode Electronics, Inc.
Q3 2015 Earnings Call Transcript

Published: 5 Mar 2015

[Operator:]

Welcome to the Methode Electronics Fiscal 2015 Third Quarter Earnings Conference Call. At this time, all participants are in a listen only-mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. This conference call does contain certain forward-looking statements, which reflect management's expectations regarding future events and operating performance and speak only as of the date hereof. These forward-looking statements are subject to the Safe Harbor protection provided under the Securities Laws. Methode undertakes no duty to update any forward-looking statements to conform the statements to actual results or changes in Methode's expectations on a quarterly basis or otherwise. Forward-looking statements in this conference call involve a number of risks and uncertainties. The factors that could 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 limitations, the following

[Doug Koman:]

Thank you, Don. Good morning, everyone. I have just a few brief comments on the quarter and the nine months period. I'd like to point out that the year-over-year third quarter and nine month sales were negatively impacted by 3.4 million, due to the recent strengthening of the U.S. dollar primarily against the euro. Additionally, other income expense net improved 600,000 in the third quarter and 1 million for the nine months period due to the net favorable fluctuation of the various functional currencies versus their transactional currencies in our foreign business units. Looking at taxes, because we no longer have the net operating loss valuation allowance to shelter domestic book income, the nine months tax rate was 24.2% compared to 8% last year. This is in line with our guidance range of a mid 20% tax rate. As mentioned on the last call, we still have tax net operating losses available which we expect will keep U.S. federal cash taxes and certain state cash taxes to a minimum throughout fiscal 2015. In the first nine months of fiscal 2015, we spent 12.8 million for capital expenditures. For the full year fiscal 2015 we expect capital spending to be between 20 and 22 that is down slightly from our prior estimate. Depreciation and amortization expense in the first quarter -- in the first nine months of 2015 was 17.5 million for fiscal'15 we expect the full year depreciation and amortization to be between 22 million and 25 million. This is also down from our prior year estimate. Looking at EBITDA, in the nine months period it was nearly 116 million or 18% of sales. Based on our fiscal 2015 guidance we expect EBITDA to remain in the 18% range and be between 157 million and 160 million for the full year. Lastly for the nine month period of 2015 free cash flow was 79.2 million; based on our guidance we expect fiscal 2015 free cash flow to be between 102 million and 108 million. Don, that concludes my remarks.

[Don Duda:]

Doug, thank you very much. Adam, we're prepared to take questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Chris Van Horn with FBR Capital Markets. Please go ahead with your question.

[Chris Van Horn:]

Good morning. Thanks for taking my call, and congrats on the quarter.

[Don Duda:]

Thank you, Chris.

[Chris Van Horn:]

Could you just give us an update on some of the new products you're bidding on now or bringing out to the market, things like SmartCenter Stack, the torque sensing, maybe HyperTouch; can you give me some color on what you're seeing out there?

[Don Duda:]

Sure, I have to be a little guarded, because this is a competitive situation, but I'll give you as much information as I can. Let me start with torque sensing. We have no business to announce at this point, but we continue to get favorable feedback from our customers and we're doing testing on that product both in Europe and United States. We would expect that we'd have some indication during this calendar year. But I think the important point there is we have not experienced any testing issues with the customers. So that continues to move forward. On HyperTouch, we continue to offer that to our clients, customers, as well as others -- as you know we announced I think probably two quarters ago we were successful in getting that technology designed in a Honda. We continue to pursue keyless entry both at Honda and others for that technology. Again, we don't have any wins to announce -- further wins to announce on that, but that continues to be very well received, and we continue to refine the technology. We talked about Dabir and that we're embarking on expanding the sales there, and as we mentioned at the last conference we attended, we're working on developing product that goes beyond the surgical suite, which we have acknowledged is a much larger market. But again, we're concentrating our sales efforts right now on the surgical area. SmartCenter console, we continue to evolve that and present that to our customers that places us I think very well -- we’re very well positioned to garner more center console business of course in the news there is all sorts of discussion on what the next center console and connectivity in the vehicle are going to be. We also on 10-gigs, we continue to invest in the chip; recently had very favorable results from testing of the first samples and anticipating that contributing to revenues in our fiscal '17. And I believe that covers the -- and I shall also talk about our lithium-ion UPS, we are very close to having our UL approval on that, and we do have a slight backlog which is good and it's depended upon shipping and it's dependent upon UL approval which we anticipate here shortly.

[Chris Van Horn:]

Okay, great. And kind of touching on the appliance market; can you just tell us what you're seeing out there? You certainly told us you expected some headwinds out of that market, but just a little more color on what's going on there.

[Don Duda:]

Sure. Our customers, particularly our largest customer is doing well. We're seeing as our major laundry program, those revenues have been affected by a -- like I said, less expensive top-load product that the customer came out with, and that's really eroding sales of the products that we're on which is a frontload much more expensive type unit. And whether that turns around or not in the next year, I think it remains to be seen. But that's really the effect. It's not so much the appliance industry as it of that particular situation.

[Chris Van Horn:]

Got it, got it. And then just one more if you don't mind, on the Trace Labs divestiture, could you just -- was that something that you were looking to sell or did someone approach you; and just kind of the thought process around the divesture, if you don't mind? And then just as a follow on to that this is kind of the second one in the past year and can we just continue to believe that you're constantly reviewing your portfolio for these types of transactions. Thanks.

[Don Duda:]

Let me answer the last question first. We continue to review our portfolio, our strategies and so on and determine what is core, what's not. Specific to Trace, Trace Labs was initiated many years ago to perform testing on Methode's products. Really before my time and Doug's time, the Founder believed that having a centralized testing lab would be beneficial to Methode and certainly has been. Years ago, what we asked Trace to do to better utilize the equipment is to take an outside business, which they were very successful in doing both here and Illinois also and Maryland. And what also happened over the years, I'd say probably in the last several years is our divisions have their own testing capabilities and in auto probably the largest that continue to grow, and not that Trace was not doing a good job. It's just the evolution of a product, some of the testing needed to be onsite, and particularly in Europe and Asia. So at a certain point, we decided that if someone were to approach us, we would entertain the sale and we were -- had been approached through the years, but at the timing seemed right and the suitor had very good credentials and we executed the sale.

[Chris Van Horn:]

Okay, great. Thanks again, congrats.

[Don Duda:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Steve Dyer of Craig Hallum. Please go ahead with your question.

[Steve Dyer:]

Good morning, Doug, good morning, Don. Good quarter.

[Don Duda:]

Thank you.

[Doug Koman:]

Good morning.

[Steve Dyer:]

I would like to dig in I guess a little bit to the sustainability of the margins; in a couple different segments you talk about raw material benefit in the quarter. Are you able to quantify that I guess a little bit more for us and then sort of how sustainable do you feel like that is as a tailwind going forward?

[Don Duda:]

Primarily the commodity was copper. And we all follow COMEX and right now, it's had a favorable effect. Whether that continues we'll have to see what the worldwide commodity does. But in general, in sustainability of margins we had very good margins in Power, probably some of the best we've ever had, certainly helped by our big data customer and in the factory efficiencies, but as I said on the call, I congratulate the team for taking cost out of the products, cost out of the factory. And we'll continue to do that, I mean we talked a lot about efficiencies in our automotive plants. We apply the same strategies in our non-auto plants and we're seeing the benefit of that in Power. The big driver there of course is sales, and Power has a very good [prime] [ph] that when the sales are at a certain point, the factory efficiencies are quite good. Is that sustainable? That is sustainable to a degree, but also is dependent upon our large customers in that area, not as a predictable business as auto. And I think we said we've got about one quarter of visibility and anticipate a similar quarter here in the fourth quarter for power. Elsewhere, I mean you saw in interface, the margins are affected there because our sales are down, again we are anticipating a little better sales in Hetronic in the fourth quarter, and we have undertaken efforts to improve Hetronic's factory and margins as well. There I would say that is dependent upon -- largely dependant upon sales. And then in auto, as I've said before we have contractual price downs that have gone into effect. There is additional ones next year that are to be in the automotive business. Our teams, they are ahead of the -- where we expect them to be in their factory improvements, in their cross-selling models and we saw the effect of that in the quarter. But in general for Methode's margins to continue to improve, we do need a non-automotive product to ramp, Dabir and all of them that I talked about from Chris' question. [End]

[Steve Dyer:]

Okay. And then I guess within auto, how much of a benefit is the Egyptian manufacturing facility, and is that going to be a bigger part of mix going forward such that these should be relatively sustainable margins in that segment?

[Don Duda:]

There is no doubt that Egypt is helping us. It's helping us in the European arena that doesn't help us in the U.S. Product to Egypt and we've been successful doing that. It has taken a little longer than we wanted, but we -- the plant has been very well received by -- from the customers and the customers have ordered it. So we will continue to transfer products as appropriate. It has to be more labor-intensive. We wouldn't take our highly automated product that we have, and also that wouldn't make sense. So it depends on products. And then, through a combination of European automotive sales to improve -- we tend to be much more conservative with our view of Europe. I think that has served us well. We would need that to improve. Of course new wins where we can launch in Egypt, a site now on Egypt, we are launching our first center console in Europe and Egypt. And that has been well received by the customer.

[Steve Dyer:]

Okay. One more auto question; this is K2 I think, this iteration, anyway this program scheduled to roll-off I think in the 2018 time period, any comments or color you can share there on the bidding to the successor program there as far as timing?

[Don Duda:]

Yes, the best answer I can give to you is we're aggressively pursuing that and this is a competitive situation. So I don't think -- I probably shouldn't make any comment on that, and I think you would understand why, but…

[Steve Dyer:]

What about just from a timing standpoint, obviously not trying to handicap anything?

[Don Duda:]

That's customer dependant. I shy away from -- I made a comment a while back on the range, and it's really up to the customer. And we're prepared when they initiate their process. But, again, it's a competitive situation, and I really think we'll leave it at that.

[Steve Dyer:]

Okay, fair enough. It's a new quarter so I had to ask you that question.

[Don Duda:]

Okay, and I appreciate that.

[Steve Dyer:]

Last question for me and I'll hop back in the queue. Dabir, maybe any commentary, you certainly gave some around success so far, maybe commentary on building up the sales channel, and when you would expect that to be material? Thanks.

[Doug Koman:]

We expect it to turn revenues from Dabir in '16. I feel at this point it will be probably more towards the second half of '16. There is a -- if you would call it designing process, that goes on at these hospitals that takes, right now we would say, about a six-month timeframe. We think that will go down as people become more familiar with the product, and there's more word of mouth, and more confidence in it. All of these hospitals rightly have their internal review board. They want to make sure the product is safe for use in the hospital. There's training of the nursing staff and so on. So we've been successful really with that approach. And we're somewhat throttled by the hospital's timeline. But we will continue to add to our sales force as we go into '16 here. And we will probably -- on average, we probably add one person or one rep a month. That might be a little light, but we continue to do that. There has to be training that goes on, there's a number of samples, and so on. So it's a process, but the good news is that it is being well received. But that'll affect our '16, but again the latter half of '16 because of the designing. And then at some point we'll see maybe a national distribution contract. But I just think we're too early to do that now.

[Steve Dyer:]

Okay, thanks.

[Doug Koman:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Jimmy Baker with B. Riley and Company. Please go ahead with your question.

[Jimmy Baker:]

Hi, good morning guys, and let me add my congrats.

[Don Duda:]

Thank you, Jimmy.

[Jimmy Baker:]

First, and this wasn't mentioned in the press release, but just from the language in the 10-Q, were you actually counting against a 14-week quarter last year?

[Don Duda:]

Yes.

[Jimmy Baker:]

Okay, so what would the apples-to-apples sales growth have been in the quarter? I assume it would've been quite a bit higher if you were adjusting for having one fewer week this go around?

[Don Duda:]

You would have had another week of sales. But I miscalculated, but it would have depended upon releases and so on.

[Doug Koman:]

Exchange rates.

[Don Duda:]

Yes. That answer your question, I don't…

[Doug Koman:]

You can do the calculations too. I…

[Don Duda:]

I don't want to.

[Jimmy Baker:]

Right, I mean if we assume that sales were equal across the quarter, each week was equal by roughly -- that makes you close, like a 16% sales growth quarter year, versus the, I think 9% you posted. Does that sound about right?

[Don Duda:]

I don't know because I'd have to do the math. But it was also a holiday quarter. But yes, suffice to say, we have an extra week of sales we'd anticipate a higher percentage year-over-year.

[Jimmy Baker:]

Yes, it's just been fairly significant. Anyway I'll move on. Just looking for some -- most of my other questions have been answered. But just looking for some help here on the other segments in light of the trade sale, it looks like you'll have virtually no revenues in that segment, until Dabir ramps. So can you just help us understand what the quarterly expense rate will be for Dabir as you ramp up distribution before you see any material revenue come through, and how we should be thinking about that heading into fiscal '16?

[Doug Koman:]

I don't know…

[Don Duda:]

Jimmy, I think that's why we gave you some color on the 2012 months of sales in pretax. So we give you some idea of the impact of removing Trace. So I don't know if we comment about Dabir expenses.

[Doug Koman:]

I think we have, in times past, said what we were spending in Dabir in our fiscal '15, and then as we, next quarter, give guidance on '16 we'll remark on the investment in Dabir. But that would all be in the other category.

[Jimmy Baker:]

Is there anything else that's material that's left in that other category besides Dabir?

[Don Duda:]

Active Energy is in there as well. And I don't know that we've given numbers on their burn, burn] but that's anticipated to ship product here once we have UL approval, and that would be significant, but those revenues would be recorded in that segment.

[Jimmy Baker:]

Okay, and then just lastly. You talked about an expectation for some improvement in Hetronic sales. Just can you elaborate a little bit on what gives you the confidence that you might finally be seeing a bottom there? And then as, in terms of the follow-on to that, the weakness that you've endured to date in that business are you fairly confident that that's just a function of end market softness, as opposed to any share loss, and so as your end markets recover do you expect to -- can you get back to prior levels there?

[Don Duda:]

There are a number of things that's happened with Hetronic. We had one customer who was placing the Hetronic product and control system on oil rigs that required another certification. The customer requested it. We had to go through that. That took a better part of, I would say, 6-8 months to obtain. That was obtained. So we will start shipping those products here in our fourth quarter, and a little bit in the first quarter of next year. So that wasn't market issue, it was a certification issue. And again, that was at the request of the customer. And then we've been successful launching a suite of products that go on service trucks. That was about a year in development. We're starting to see revenues from that now. So those are two very positive developments, both domestic. In Europe, we still see economic pressure in the industrial area. We'll see some improvement there. So if you ask me, we've seen the bottom. I'd like to think so. Internally, we've revamped our product. We've taken a really auto approach to how we are approaching development, and our manufacturing systems that ultimately should improve the margins, and reduce our lead time in Hetronic. So in summary, I remain very enthusiastic about Hetronic moving forward. We've had some pressures there, but just as we've seen with Power. We've been working with Power for a number of years now to get their factories where they need to be, and we saw very good results this quarter. And we would expect that at some point in the future, I'm not necessarily saying when, but that Hetronic will be a major contributor for us.

[Jimmy Baker:]

Perfect. Thanks a lot Don. I really appreciate the color.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of David Leiker with Robert W. Baird. Please go ahead with your question.

[Joe Vruwink:]

Hi, good morning. This is Joe Vruwink for David.

[Don Duda:]

Hi, Joe.

[Joe Vruwink:]

While we're on the topic of Hetronic, can you give some sort of reference points to maybe where revenues stand relative to where they trended or where they peaked during last cycle?

[Don Duda:]

I don't know if we have that readily available here but that's something that we can I think provide. Yes, I've got -- we can provide that. And are you talking when you said last cycle, you're talking '14?

[Joe Vruwink:]

Well, I guess kind of the period from when you acquired it to I'm guessing that's probably '08 timeframe.

[Don Duda:]

Oh, we're not yet approaching there. I think they're peak revenue. If that's the question, I can definitely say that. So that was acquired pre-recession and while we feel this recovered in the US the major market was in Europe and that still isn't anywhere is near where it was. And that's a market factor, not a business not an internal factor. Doesn't have room to grow? Yes.

[Joe Vruwink:]

Okay. The reason I ask is, looking at Interface margins today and let's say they finish the year around 25%, this business was closer to 30% at one point. How much of that five point difference can you directly attribute to Hetronic versus some of your other products?

[Don Duda:]

I think the hit in interface is in appliance. Appliance carries less margin than Hetronics, but the revenue decrease that has been really been the biggest factor now. Hetronic sales has higher margin depending on the product which could as it could offset that decline. I don't think we're planning on that happening on next year, but that certainly can have that effect. Hetronic is one of our best margin products. And then also in interface, as we embark on 10-gig, that will also hit the margin contributor that's -- so 1-gig is a good margin contributor and then 10-gig is -- the hit we have taken on margin is appliance -- for the most part appliance-related.

[Joe Vruwink:]

Okay. Shifting over to Power Products, you mentioned earlier that you kind of have three months visibility into a lot of that business, so back in December when you provided updated targets were you seeing the inflation in demand across all the regions at that point?

[Don Duda:]

That's a good question. We were seeing -- and to some degree we're seeing that now where our major customers segment is indicating that the next three months maybe a little less demand. So yes, we say we have three months visibility, but it does vary within that quarter. So when we went into last quarter, we weren't seeing a strong demand as we ended up and that's -- that can go the other way as well. These are -- most of the products that Power makes is dependent on our customers bill cycle. So the most no one have to carry inventory. So you will see increase in the demand, I think varying of a one month till the next. It's a harder business to predict we got to the customers, but it can vary. When I say minimum three months, that's part of a good beginning and again it can vary.

[Joe Vruwink:]

Is it all a function of market demand or, because these products are in pretty fragment to markets and there's a lot of competitors. Do you see any share shifts where you really attribute some of the growth to your sales team and going out and getting the wins?

[Don Duda:]

Well, it is a design end. You get print position. Sometimes you are sole sourced, which is what we we prefer. Sometimes its dual sourced. In that case it will be the supplier that can deliver the product; earlier than their competitor, and to some degree what we've seen is, I mean again we are applying our auto discipline. Power runs -- going from memory, about 96%, maybe sometimes a little higher on time. Across the board we target 100%, but because they even proved that dramatically when that call comes in can you deliver the product in X amount? And the answer is yes, you get the business and the competitor doesn't, assuming they have longer lead time. So to that degree, we can influence the buying decision, and we do see some of that. That's also not uncommon to have a Mill Arrow program get funded and they are upgrading a particular vessel and we are getting the order beginning of the quarter and we ship it by the end. So it is design and depend on the sales and ship comes I think on the design in side. And what's your design-in here, the price is set, it's really delivery and when the customer needs the product.

[Joe Vruwink:]

Okay. The last one for me, you touched on a piece of it. Each of your businesses has a manufacturing target. When you look at Automotive, I would imagine when you open the low cost facilities there was an initial target for just the fact that overhead was going to be less and then probably moving up some sort of efficiency curve whether it's throughput or scrappage. When you look at Egypt, or really any of your low cost facilities, where is the efficiency relative to maybe your best in class facility? And are you happening to move the targets higher, which is why really margin improvement isn't so much being tied to revenue improvement at this point?

[Don Duda:]

I don't think it's tied to both, revenue and cost reductions. Egypt is our very youngest plant. So we would expect that it would continue to improve. Our Asian plant is probably and the Maltese plants are probably the most matured, but they continue to take cost out. The whole lean manufacturing process is continued improvement. So what was good enough last year is not good enough this year, so we continue to raise the bar. Now, realistically we have a five-year old product, how much cost can you pick out of it. A lot of diminishing returns comes into play. We had customers come in, and as you know, auto -- customers will come in and will look for -- they will try to help you with cost reduction. We've had customers come in particularly in Asia, where they can't find anything. So, a lot of diminishing returns come in of the younger plant, maybe the more products that you run through with more opportunities than exist. We set new goals on every year, not just for cost reductions, but for on-time delivery, quality, and we will review those once a month at our ops review. And if they are missing the goal, they have to have corrective actions, so that's just part of how Methode operates, not just in auto, but in non-auto.

[Joe Vruwink:]

Okay, I'll leave it there. Thanks.

[Don Duda:]

Thanks, Joe.

[Operator:]

Thank you. Ladies and gentlemen, there are no further questions at this time. I would like to turn the floor back over to Mr. Duda for closing remarks.

[Don Duda:]

Adam, thank you very much. And we'll thank everyone for listening and their questions, and wish them a good day. Thank you.

[Operator:]

Ladies and gentlemen, this does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.