Don Duda – President and Chief Executive Officer Doug Koman – Chief Financial Officer

David Leiker – Robert W. Baird Jimmy Baker – B. Riley Steve Dyer – Craig Hallum

Welcome to Methode Electronics Fiscal Year 2016 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 confirm 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 limitation, the following; dependence on a small number of large customers, including two large automotive customers; dependence on the automotive appliance, computer and communications industries; investment in programs prior to the recognition of revenue; ability to withstand price pressure, including price concession, currency fluctuations, timing, quality and cost of new program launches; dependence on our supply chain; dependence on the availability and price of raw materials; customary risks related to conducting global operations; income tax fluctuations; fluctuations in our gross margins; the recognition of goodwill impairment charges; ability to keep pace with rapid technology changes; a breach of our information technology systems; ability to compete effectively; ability to successfully benefit from acquisitions and divestitures; ability to avoid design or manufacturing defects; ability to protect our intellectual property; location of a significant amount of cash outside of the United States; ability to withstand business interruptions; 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.

Thank you, Adam and good morning, everyone. Thank you for joining us today for our fiscal 2016, third quarter financial results conference call. I'm joined today by Doug Koman, our Chief Financial Officer; and Ron Tsoumas, our Controller and Treasurer. Both Doug and I have comments and afterwards we will take your questions. Sales for the fiscal 2016 third quarter decreased 10.4% and in the first 9 months, declined 8.8%, with lower sales in all segments, most notably Power Products. Net income decreased in both periods affected mainly by lower sales in the corresponding manufacturing inefficiencies, but was also impacted by pricing concessions in the automotive segment, increased legal fees, particularly related to the Hetronic litigation, higher professional fees as well as increased expenses for wage, benefit, stock award compensation, and intangible asset amortization. The first nine months was also negatively affected by costs and inefficiencies due to the transfer of Interface manufacturing from the Philippines to Egypt in the first quarter. Partially offsetting these unfavourable factors in both periods were lower income tax expense, favourable foreign currency translation for raw materials and labour costs, and favourable raw material commodity pricing. The nine month period also benefited from lower bonus expense. Consolidated gross margins as a percentage of sales declined 150 basis points in the third quarter, but were constant year-over-year for the first nine months. In both periods, gross margins were negatively impacted by manufacturing inefficiencies related to decreased sales. In the third quarter, pricing concessions in the automotive segment also negatively impacted gross margins. While the nine months were also affected by the transfer of Interface manufacturing from the Philippines to Egypt during the first quarter. Consolidated gross margins were positively affected in both periods by favourable currency impact in raw materials and labour, costs and favourable commodity pricing on raw materials. Year-over-year third quarter and nine months selling and administrative expenses were negatively affected by higher legal and professional services as well as expenses for wage benefits and stock award compensation, and intangible asset amortization. The nine month period benefitted from lower bonus expense. Third quarter operating margin was 11.6% compared to 16.8% last year, while nine months was 13.1% compared to 14.9% year-over-year. We have reaffirmed fiscal 2016 guidance for income from operations in the range $104 million to $110 million, and earnings per share in the range of $2.06 to $2.18. Fiscal 2016 sales guidance has been revised to the range of $790 million to $800 million. Based on this guidance range, our fiscal 2016 operating margin target is in the 13.3% to 13.8% range. Despite our reduced expectations for sales in fiscal 2016, we remain confident that our operating income and earnings per share will approximate the midpoint of the ranges. While third quarter profitability met our expectations, revenue was lower than we previously expected when we reported the second quarter, due to prolonged weakness in our non-Automotive businesses particularly for our products and solutions that are serving the industrial and energy markets. We expect this will continue into the fourth quarter. Moving on to a review of our segment results, as compared to last year, Automotive segment sales declined 1.8% in the third quarter and 2.3% in the first nine months as a result of lower volume Ford center console program, lower steering angle sensor product volumes as well as pricing concessions. These declines were partially offset by higher General Motors’ center console program volumes, improved tooling sales, and increased hidden switch product volume in our European operations, as well as higher linear position and interior lighting product volumes in our Asian operations. Overall, year-over-year transmission lead frame volume declined in the quarter, but improved in the nine months. Exchange rates negatively impacted Automotive sales by 2% in the third quarter and by 2.8% in the nine months. In the third quarter, Automotive gross margins improved to 26.9% from 26.3% and in the first nine months to 27.5% from 25.1%. In both periods, the favourable currency impact, and raw materials and labour costs and favourable commodity pricing in raw materials were partially offset by pricing concessions. For fiscal 2016, we're still targeting Automotive gross margins in the mid-20% range. Moving to our Interface segment, year-over-year sales decreased 5.7% in the third quarter and 14.1% in the first nine months, due mainly to lower appliance and data solution product volumes in North America. In Europe, year-over-year data solution volumes increased in the third quarter as well in the nine months period. Compared to last year, Interface gross margins as a percentage of sales were constant in the third quarter, but decreased for the nine month period. However, on a dollar basis, gross margin decreased in both periods. In the third quarter, gross margins were negatively impacted by manufacturing inefficiencies related to reduced sales partially offset by a variable sales mix and decreased raw material and direct labour costs. In the nine months, Interface gross margins were also negatively impacted by costs associated with the transfer of manufacturing from the Philippines to Egypt and reduced sales. Without the costs associated with the relocation of manufacturing, Interface’s first nine months' gross margins would have been 24.7%. For fiscal 2016, we are targeting Interface gross margins in the range of 23% to 25%. Moving to Power Products, net sales decreased 56.7% in the third quarter and 38.8% in the first nine months compared to last year. In both periods, we experienced significantly lower sales to our big data customer as well as reduced Asian bus bar and cabling products, and European bypass switch product volumes. Looking forward, we are anticipating sales in the segment, which is typically one of our highest margin businesses, will continue to be considerably lower than in fiscal 2015. However, we do still anticipate the return of our big data customer late in the fourth quarter albeit at substantially lower sales than the previous program. At this point, we're expecting approximately $9 million in average annual revenue in fiscal 2017 through 2019 on this new program. Year-over-year, segment gross margin decreased to 19.5% from 40.2% in the third quarter and to 18.4% from 33.8% in the first nine months due to lower sales and the corresponding manufacturing efficiencies. For fiscal 2016, we're targeting Power Products gross margin in the mid-teens. Before moving on to an update on Dabir, I'm pleased to announce that during the third quarter, Methode purchased $37 million or over 1.2 million shares of its outstanding common stock at an average purchase price of $30.63 under the Board approved, authorized $100 million repurchase plan. Through the end of the third quarter, under the plan, we repurchased over 1.9 million shares, and had just over $40 million of remaining availability. Now, let's move on to developments with our Dabir Surfaces since our last call. Customer adoption has increased with the addition of three new domestic hospitals committing to purchase products from long duration surgeries. We've now surpassed over 1,000 surgeries using a Dabir surface. Recently, our beta hospital, which has logged the most surgeries to date and continues to expand the use of Dabir surface to additional operating rooms commented as follows. The Dabir surface has truly been instrumental in eliminating deep tissue injury for our heart cases over the past 18 months. Having this level of protection is not only a good thing to do, but is the right thing to do for our patients. With its ease of use, from set up to cleaning, the Dabir surface has played a critical part in the overall care of our cardiac surgery patients. The Dabir team has heard similar comments from other users. Additionally, several other hospitals are also in the process of concluding product evaluations and initial reports from these have also shown successful clinical outcomes. Interest from the Veterans Administration, skilled nursing facilities, rehabilitation centres and home care providers has also increased. On the clinical front, we continue engagement activity at multiple teaching hospitals. The Henry Ford Health System study is progressing with operating room ICU patients now being added after initial success in the operating rooms. In parallel to other studies we'll target profusion but of course, looking at long term outcome. Completion is estimated for fall of this year. Additionally, we have retained the Marwood Group, a respected international healthcare advisory firm to substantiate diverse addressable market. In the first phase, Marwood focused on confirming Dabir's value in acute care surgical and bed applications, non-acute care skilled nursing facilities and homecare settings. Additionally in phase two, Marwood is currently exploring assumptions for reimbursement, regulatory outlook, competitive positioning and clinical assessment. Their word continues to verify what Dabir has seen in the market, that the largest number of pressure ulcer patients is in the hospital setting with over 1 million pressure ulcer reported in 5,000 hospitals nationally. The study also confirmed that our next step in product development should be patient rehabilitation, assisted living, skilled nursing and homecare markets. As I mentioned, there's a great deal of interest from skilled nursing facilities as well as home healthcare providers. The Marwood study shows that, of the non-hospital segment these two areas have the highest incident rates for pressure ulcer development, with some reporting as high as a 10% incident rate. This confirms for us that we are entering an area where the current solutions are not adequate. Now, I'll turn the call over to Doug who will give further details regarding our financial results.

Thank you, Don. Good morning, everyone. I've just got a few brief comments on the quarter and the nine months. The effective tax rate for the nine-month period was 23.1%. That's up slightly from the six month period and is due to the shift in expected taxable income in the jurisdictions in which we operate. This amount remains within the guidance range of low to mid 20s. As Don mentioned earlier, year to date, we've repurchased 1.9 million shares. We've spent $59.8 million to do that, and most of that came from borrowings under our credit facility. In the nine month period, the reduction in shares as a result of a share repurchase program was just under $0.02 improvement to earnings per share. If there are no further repurchases made during the fiscal year, the expected benefit to full year earnings per share would be just over $0.02. You'll note that in the third quarter, SG&A as a percentage of sales was 14.1%. Sequentially, this is an increase over the 11.4% and 11.8% in the first and second quarters perspectival. In addition to the legal and professional fees, a contributor to this increase was the award of performance based restricted stock awards and restricted stock units to key employees late in the second quarter of fiscal 2016. The amortization expense for these long term incentive awards during the first half of fiscal 2016 was only $800,000, all of which occurred in the second quarter. During the third quarter, the expense related to these items was $2.4 million, and we expect the amortization expense will be the same in the fourth quarter. For the nine months of fiscal 2016, we spent $17.2 million for capital expenditures. For the full year, we expect CapEx spending to continue to be between $20 million to $25 million. That's in line with our prior estimate. Depreciation and amortization expense in the first nine months was $17.8 million. For the full year, we expect that to be within the $23 million to $25 million range, and this also is unchanged from our prior estimate. EBITDA in the nine months was $97.6 million, just over 16% of sales, and based on our 2016 guidance, we expect EBITDA will remain in the 16% range and be in between $127 million and $133 million. Free cash flow for the nine months was $62.5 million and again, based on our guidance, we expect the free cash flow for the full year to be between $82 million and $87 million. Don? That concludes my remarks.

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

[Operator Instructions] Our first question comes from the line of David Leiker from Baird. Please go ahead.

A couple of things I just want to run through you if we could, on the Power side of your business, is that -- how much opportunity did you have there to take cost out of the business or you just to have to wait for the volumes to come back there?

We have taken costs out of the business. We continue to do that. We operate most of our businesses fairly lean, so we do need increased sales to get back to where they were.

And the, you were talking about your customer coming back here in the fourth quarter, I mean, we're pretty deep into your quarter, are you starting to see that?

Yes, we are, but again, it's late in the fourth quarter where we're expecting our revenue, but all indications are we'll see that. The bigger effect is next year.

Then, as we talk about Dabir, a couple of questions as relates to there, I'll just kind of throw them all out and you can address them as you can. First piece of it would be, are you seeing any negative incidents or non-benefit incidents there? Is there any way to verify some of the savings that the institutions are seeing on this and then the third, are you seeing any competitive reaction in the marketplace now that you're becoming more visible?

We have not seen any negative effect. Nothing has been reported and, we've got not just our beta hospital, but the clinicals that are going on now plus a number of hospitals are evaluating and so we've not had any negative reactions. We've had to make sure that the surface works with a particular operating table or whatever, an environment a particular hospital is using. Some have to work with heating elements and so on. We've had that, but those have all had the positive outcomes. We continue to refine the savings model. The hospitals do save money. That's a calculation they need to do on their own. They're not going to share with us their exact incident rate. We do provide them a model. We've also added to our thinking that there is litigation that comes from these pressure ulcer, particularly the, I believe the stage four are the most severe, that in certain instances is getting factored. And, from a competition standpoint, the overall comment I'll make is that Dabir is on the map. People are paying attention to it. It's not an unknown. Each hospital as I was saying earlier has some unique requirements but they have heard of it. We've not seen competition in the OR. It doesn't mean that someone's not planning on that, but -- and we've had inquiries from not the management of some of our competitors, but more from the sales group who maybe, they're selling an operating table and have been requested to provide some sort of a surface and so Dabir gets some recognition, and that I think was actually positive. Specifically has a competitor come out with a competing -- or someone in that business, have they come out with a competing product? No.

Then, just one last item here. The borrowing, you said is for share repurchases. I don't recall how much of your cash is overseas. I'm presuming the majority of it.

Yeah, right. About 95% is offshore.

Our next question comes from the line of Jimmy Baker from B. Riley. Please go ahead.

Just first a question on the guidance. What are you assuming for the shares outstanding? It just seems like it's not possible for you to come in at both the midpoint of the operating income and earnings guidance because you bought back so many shares that was not in the prior guidance.

Yeah Jimmy, we bought back 1.9 million shares, but the calculation of diluted shares outstanding is a weighted average over the year. So, that's why -- we're factoring in about that $0.02 that I commented on.

So, is the full year share count around, call it the January quarter share count, 38.3 million or so?

Well, if you're talking about on a going forward basis, yeah.

No, the weighted average for the year.

Well, for the year, it's 38.7 million, I think. We're just checking. It's on the face of the Q. if you're talking about the shares outstanding that we posted on the Q. It's 36.9 million, okay, but on the calculation for diluted shares outstanding for the nine month period, we're at 38.8. It'll probably go down when we pick up the fourth quarter.

Right, okay, understood, but you can't give that number yet, because you don't want to telegraph what you're buying here in the fourth quarter?

Yeah, we don't comment on any activity in the current quarter. Correct.

Okay, fair enough. So, really strong Automotive gross margins here. I guess, is your expectation that just looking at your backlog and as we move into next fiscal year, where you might be able to resume some modest growth in that business, if that's the case, how should we think about, I guess, improved cost absorption and any implications from product mix going forward?

Okay, if we assume a constant volumes over what we're seeing this year, we do have more launches that are occurring. So, we'll see added volume and the related overhead coverage from that, but the comment that's important to make is, we also have price reductions that -- contractual price reduction will also kick in. So, at this point when we've not said anything about our Automotive gross margins for next year, we have commented on what we think the fourth quarter, or actually the full year will be and that's a number I would use for now. We'll have to see how buyers materialize and particularly with our major customers, we go into the midpoint of this calendar year, but the price reductions are something we need to point out, need to get factored in.

Of course. Okay. Then just a few follow ups on Dabir. I guess, first, any preliminary quantification of the market opportunity from Marwood and, I guess more broadly, have they uncovered anything either positively or negatively that's surprised you thus far?

Surprised? I was comforted that they confirmed the size of the market actually is larger than what we had been using, particularly when you get into the non-acute area. Those numbers -- 10% incident rate. The opportunity there is quite large. I won't call that a surprise, but it was comforting to have that confirmed. We continue -- they're really into their phase two now and we've asked them to go back and study a few more areas in the acute care. So, as we move forward and we give presentations, we'll add more of that. I just wanted to get the initial results of that out. It did confirm our belief in both areas, acute and non-acute, the total available market is quite large for us.

Okay, and then just lastly, I think you have Dabir clinical that are due to complete in your fiscal second quarter. I guess, how material are those to accelerating hospital adoption and what other milestones should we be looking towards?

Okay, to answer the second question, I mean the milestones are adding more hospitals, and I think I've said before that the more hospitals we add, particularly when we get to -- we add a large buying group, that's when the Dabir snowball starts to roll. I think that's key, but that's also triggered by when we can give concrete evidence by these clinicals, third party clinicals that the Dabir surface operates as intended. Right now, what we're having to do is, each hospital is doing their internal review and we're getting favourable results, but that lengthens the adoption cycle. So, with the clinicals in the fall, I think that is key to proving to the new user or the perspective user that Dabir operates as a 10 and then also as it rolls out to the larger hospital groups, those are really the two milestones that I look for. Then, at some point, I won't put a timeframe on it, getting a nursing home group to start using the Dabir surface that would also be a major milestone for us.

[Operator Instructions] Our next question comes from the line of Steve Dyer from Craig Hallum. Please go ahead.

Within Auto, I don't know if you'll call this granular, but how much maybe was the GM business up year-over-year versus the Ford business down year-over-year? Trying to kind of figure out the delta between those two.

We know that. I'm not so sure we can answer that. I'm getting in an area, we probably have to talk about customer -- I mean, the Ford, what I can say is, the Ford center console business rolling off had a, was it $30 million?

Yeah for the year.

For the year, $30 million, but as far as volumes, one way or the other, on the automaker, I don't think I should comment.

But that's -- Ford is substantially all rolled off now right?

Just about. There's $5 million to $6 million that's still there.

Okay, and then within GM particularly, the K2 and the 31XX, I mean, are you as penetrated as you're going to be in terms of content now, there such that that's just kind of a volume story at this point in time or are there still additional content or additional variation to those platforms that you may get in?

We're launching a program this coming -- it didn't launch now, but it will turn revenue here in fiscal '17. So, then we've announced that prior, so that'll be additional business form the K2 platform, but in terms of adding any additional, no we won't see that. We're in the third -- 3.5 years into the program. Now, if they choose to carry something over then we'll see more volume from that. Our opportunity with GM is on new programs that we have access to because we've performed well on the K2, and you're right, it will be volume dependent if GM continues to market share, then we would benefit from that, and of course the other way around would be to our determent.

Okay, and along that vein, anything new in terms of new programs either within GM or outside on the auto side that -- you got one of the big ones, I think the F-Series is down the road, I don't know when the bidding process would begin on that, et cetera, but any color as to sort of what you're seeing on the bidding side or the winning side of deals within auto?

The 150, our guess is that it's probably two years out, but we do -- we are positioning ourselves for that. We generally don't comment on programs we haven't booked yet for competitive reasons. We gave a lot of color on Dabir, because we're spending a fair amount of money on that. I don't think it's important that we comment on it. It's difficult to comment on automotive programs we're pursuing for competitive reasons, but we are seeing opportunities at both of our major customers for additional center console business and with the launch of our first center console in Europe, we're seeing opportunity there pursuing those. I mean, we're on the bid list. I just have nothing that I can announce at the moment, but we are mixing it up in those areas and seeing good opportunities, although not quite as large as the K2 or the 150.

Then lastly for me, and I know you don't kind of guide out past this year, but as you look at all the different, kind of moving pieces, you used to put out that rolling bar graph that talked about the book business out a number of years. The last one that you gave, which is now very dated now had 2017 booked business up $929 million. Any color as to just big picture how we should think about fiscal '17? I mean, I'm assuming you expect to grow and so forth, but just any broad strokes to kind of help investors think out past the next quarter here?

Let's talk about auto first. At the moment, if the desire stays strong, which it has been and there's some people out there saying that it's going to grow, that's a positive effect for Methode as we enter next year. We're on some very popular programs and the price of gas has helped and for the last several years it's been a great tailwind for us and at this juncture, I think we would expect that to continue, plus we have some new launches. If I look at Europe, we're anticipating to grow in Europe, but that's a little dicier than the U.S. We've said this in the past. We've seen it go up and we've also seen it go down from quarter to quarter. It's a little harder to peg. So, we think that'll be down year over year, although now wildly and again, it's almost too soon to peg that. Now, auto is probably the bigger question mark, we know that our big data customer's slated to return. So, that'll help our Power Products. We've seen more quote activity in Power, but those are 18 to 24 months out generally. On existing programs, we've seen some increased activity for the future, but very hard to peg that. It's something we're working on now, and obviously when we get into our next earnings release, we're going to have to provide color on all of that, but if I look at non-Auto, across the board, some people refer to an industrial recession, we've seen our big customers significantly affected by a reduction in their business. So we're going to have to decide here fairly soon how we want to view that. Is that something that'll impact -- continue to impact our first quarter and by the end -- by the time we get to mid-year next year, is that behind us, that's going to be difficult to judge. We've seen almost all of our Power Products down. CISCO is down. We've seen Whirlpool -- oil and gas, you've probably heard me mention, Halliburton and that was a very good customer for us in the last 12 months and we're seeing significantly reduced sales. It's important to point out, we're not losing business. Customers are just not ordering as much. So that, we're wrestling with that now. I think the good takeaway from that is, Auto is strong. We've seen we've got good margins. We operate those businesses very, very well. We'll continue to generate cash from that. It's just, what's the effect of the non-Auto segments on our business.

Just lastly, you mentioned that the cash generation still is significant. Can you just kind of remind us kind of your big picture uses for that from a capital allocation perspective?

Sure, I mean, we continue to use it to fund our growth program. We're putting money into Dabir and 10 gig products, plus our general product development in Automotive, plus any vertical integration. So, that's a key use for it. Dividend, we continue to be very favourable to paying a dividend each quarter. Stock buyback. I'm not going to comment on what we're going to do going forward, but you've seen, we've made a serious commitment to doing that, by the results in the first nine months here. Acquisitions, that remains a very key focus. We have -- it's one of those things you don't really comment on until you've actually announced one, but we have some very serious discussions with particular targets. Nothing has come of any of that yet, but that would be the short of a stock buyback that's our key use. Pointing out that, 95% of our cash is overseas, so not only do we look at domestic acquisitions, we look to overseas as well and almost the ideal one is one that has domestic entities and foreign entities as well.

Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I would like to turn the floor back over to management for closing comments.

Adam, thank you, very much and we'll thank everyone for joining us today and have a good day. Thank you.