Don Duda - President and Chief Executive Officer John Hrudicka - Chief Financial Officer

Christopher Van Horn - B Riley, FBR Erin Welcenbach - Robert W. Baird Ryan Sigdahl - Craig Hallum Group

Welcome to Methode Electronics Fiscal Year 2018 Second 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 communications industries; investment in programs prior to the recognition of revenue; timing, quality and cost of new program launches; ability to withstand price pressure, including price reductions, customary risks related to conducting global operations, currency fluctuations, the effect of any material modifications to NAFTA and other international trade agreements; continued economic challenges in Europe including the exit of the United Kingdom from the European Union; location of a significant amount of cash outside of the U.S.; ability to successfully market and sell Dabir Surfaces; the success of Pacific Insight and Procoplast and/or our ability to implement and profit from new applications of the acquired technology; dependence on our supply chain; income tax rate fluctuations; ability to withstand business interruptions; dependence on the availability and price of raw materials; fluctuations in our gross margins; ability to keep pace with rapid technological changes; a breach of our information technology systems; ability to protect our intellectual property; ability to avoid design or manufacturing defects; ability to compete effectively; ability to successfully benefit from acquisitions and divestitures; the recognition of goodwill impairment charges; costs and expenses due to regulations regarding conflict minerals; and the effect of changes to U.S. tax policies. It is now my pleasure to introduce your host, Don Duda, President and Chief Executive Officer of Methode Electronics.

Thank you, Tim, and good morning, everyone. Thank you for joining us today for our fiscal 2018 second quarter financial results conference call. I am joined today by John Hrudicka, our Chief Financial Officer; and Ron Tsoumas, our Controller and Treasurer. Both John and I have comments and afterwards we will take your questions. Year-over-year fiscal 2018 sales increased 9.9% in the second quarter and 7.5% in the first half. The fiscal 2018 periods include sales of $7 million from Pacific Insight and $9.1 million from Procoplast. Excluding sales from the acquisition, sales increased 2.2% in the second quarter and 3.5% in the first half. However, earnings per share decreased to $0.64 from $0.66 in the second quarter and to $1.19 from $1.23 in the first half, due to several factors. In both periods, we incurred acquisition related expenses and purchase accounting adjustments of $4.2 million for the quarter and $6.8 million for the six months, as well as increased intangible asset amortization expenses of 0.5 million related to the Procoplast and Pacific Insight transactions. Additionally, the second quarter of last fiscal year included an international grant of 1.5 million. We also increased our investment in sales and marketing, clinical resources, and professional services for Dabir. We experienced unfavorable currency impact on labor and factory expenses, as well as unfavorable commodity pricing of certain raw materials. And finally, first half of last year benefited commodity pricing adjustments of $1 million and one-time reversal of accruals related to customer commercial issues also valued at a million dollars both in the automotive segment. Partially offsetting these factors to both periods were higher sales in the automotive and power product segments, and lower legal and lower income tax expense. Compared to last year's second quarter, consolidated gross margins improved 30 basis points to 26.9%, driven mainly by higher sales. Gross margins remain constant at 27.3% in the first half. In both periods, gross margins were negatively impacted by purchase accounting adjustments from acquisitions, unfavorable commodity pricing, and increased investment in Dabir. The second quarter was also negatively affected by price reductions and the unfavorable currency impact. The first half was also impacted by the absence of the commodity pricing adjustments and reversal of commercial accruals in the automotive segment in the fiscal 2017 first quarter. Year-over-your selling and administrative expenses increased in fiscal 2018 second quarter and first half. We did experience lower legal fees and reduced expenses related to connectivity, but those were offset by the M&A expense, selling and administrative expenses from the acquisitions, increased investment in Dabir, as well as higher travel, advertising, and marketing expenses. Year-over-year fiscal 2018 operating income was $29.7 million in the second quarter, compared to $29.1 million in the previous year. For the first half, operating income was $55.1 million this fiscal year, compared to $55.6 million last year. Second quarter operating margin was 12.9% this year, compared to 13.9% in the fiscal 2017 second quarter. For the first half operating margin was 12.8% in fiscal 2018, compared to 13.9% last year. As previously mentioned, the company incurred 6.8 million of acquisition-related expenses and purchase accounting adjustments in the first half. Moving on to a review of our segment results, automotive segment sales increased 13.7% in the second quarter and 10.2% in the first half, compared to last year due to sales from Procoplast and Pacific Insight, as well as higher customer funded tooling and design fees and increased hidden switch sensor and user interface product volumes. These improved sales were partially offset by lower transmission lead frame assembly and steering angle sensor product volumes, as well as price reductions. Year-over-year automotive gross margins declined slightly by 30 basis points in the second quarter and 60 basis points in the first half, due to price reductions, acquisition-related purchase accounting adjustments, and an unfavorable currency impact. The first half is also affected by the absence of the commodity pricing adjustments, and one-time reversals of accruals related to customer commercial issues, which occurred last year. For fiscal 2018, we are targeting automotive gross margins in the mid-to-upper 20% range. Moving to interface, year-over-year segment sales decreased 10.8% in the second quarter and 10.4% in the first half, driven mainly by the exit of connectivity and lower legacy product sales in Asia. These decreases were partially offset by higher appliance sales and increased radio remote control sales in Europe. Compared to last year, Interface gross margins improved to 22.1% from 19.1% in the second quarter, and to 21.9% from 21.2% in the first six months, due mainly to higher radio remote control sales, partially offset by overall lower sales. The second quarter was also negatively affected by price reductions and favorable currency impact. For fiscal 2018, we are targeting Interface gross margins in the high teens to low 20% range. Second quarter Hetronic litigation costs were 2.1 million this fiscal year versus 2.3 million last year. For the six months, these costs were 4.5 million and 6.6 million last year. We anticipate litigation cost in the second half of the year will be similar to the first half. In our power product segment, sales increased year-over-year by 15.2% in the second quarter and 20.8% in the first six months, due mainly to higher bypass switch volume in Europe and increased busbar volume in Asia. In the second quarter, we also experienced improved PowerRail sales. While PowerRail sales were up year-over-year in the second quarter, as we indicated on last quarter's conference call, our cloud computing customer to gross product and originally anticipated in the first half. Our customer does anticipate resuming to their prior ordering levels about mid-third quarter. As such, we now anticipate approximately $8 million to $11 million in sales this year, down from the $12 million to $15 million we originally budgeted. Year-over-year segment gross margin in the second quarter increased to 26.4% from 24% and in the first half to 27% from 26.1%. In both periods, the effective higher sales was partially offset by unfavorable commodity pricing. For 2018, we are targeting power products gross margins in the mid-20% range. As we indicated in the release this morning, Methode updated fiscal 2018 guidance to sales in the range of $880 million to $900 million from $807 million to $827 million, primarily due to sales from acquisitions, but maintained pre-tax income from operations in the range of $114 to $127 million and earnings per share in the range of $2.43 to $2.63. This guidance includes approximately nine months of Procoplast and seven months of Pacific Insight’s projected results. John will provide a more detailed discussion on our guidance in his remarks. The guidance range for fiscal 2018 are based upon management's expectations regarding a variety of factors and involve a number of risks and uncertainties, which have been detailed in this morning's release and Form 10-Q. Moving to new business, we were awarded an additional overhead council program from our North American OEM strengthening our position with this customer and our stature in this category. Launching in fiscal 2020, this represents annual revenue of 1.5 million, but more importantly brings our total business with this product to $37 million in our fiscal 2021. Additionally, in Europe, we were awarded a new generation electric park brake for two high volume programs, Volkswagen launching in fiscal 2020 with an average annual revenue of $5 million combined. There is a potential for additional program wins if the new generations which migrates to other models. Touch sensor was awarded another new laundry user interface platform from Whirlpool. Specifically, this award involves integrating a high-resolution touchscreen directly into a washer or door assembly. We anticipate annual revenues of $8 million for the start of production in mid-fiscal 2019. This latest award comes in the heels of a $14 million laundry user interface console award from Whirlpool announced at the end of fiscal 2017. Finally, our power product segment was awarded various busbar programs beginning in our fiscal 2020 for approximately 2.2 million in annual revenue. Overall, the Methode’s first half we booked approximately 38 million in new annual revenue. Now let’s move on to an update on Dabir. As we announced in the release this morning, three major health systems began initial adoption of Dabir during November, and we anticipate its expansion in additional care settings. These health systems, our Loma Linda University Health in California, Porter Adventist Hospital in Colorado, and Aurora Health Care in Wisconsin. Coupled with the ongoing research by the Cleveland Clinic in Ohio and Beaumont Hospital Dearborn campus in Michigan, we believe we have made important progress in market adoption and establishment of Dabir is a standard of care, all the way protecting thousands of patients from pressure injuries. Dabir has begun new and concluded evaluations at many major hospitals and patients. The evaluations have performed flawlessly and the clinical evidence is compelling. We are now driving adoption with those perspective customers. Further, we have additional health systems [indiscernible] evaluation over the next few months and will continue at an accelerated pace. This acceleration is being driven by the clinical evidence, an addition of both sales and clinical representatives was significant healthcare experience. Additionally, many of these systems have expressed interest in undertaking research what will further expand the clinical evidence supporting the efficacy of Dabir. We will remain excited about the future of Dabir, and our ability to continue our mission to prevent pressure injuries for patients. Now, I will turn the call over to John who will give further details regarding our financial results. John?

Thank you, Don. Good morning everyone. I have just a few brief comments on the quarter and six-month period. Before I begin my commentary, I want to clarify my comments include one month and three months results for our acquisitions in Pacific Insight and Procoplast respectively. The effective tax rate for the six-month period was 17.1%, this is down from prior year and below fiscal 2018 guidance. Primarily related to the composition of earnings and jurisdictions with lower tax rate and a few discrete tax adjustments. These discrete items, including reporting a tax benefit associated with the write-up of our deferred tax benefits related to an increase in State of Illinois corporate income tax rate from 7.75% to 9.9%. In addition, we recognized a deferred tax asset for tax losses related to a foreign jurisdiction that continues to improve its profitability. The other favorable tax adjustment was related to the new accounting rules for stock-based compensation. We are lowering our range for the overall effective tax rate for fiscal 2018. We expect our full-year rate to be in the 17% and 19% range. This is primarily due to earnings in jurisdictions with lower tax rates, generation of foreign investment tax rate credits, and the effect of the discrete tax adjustments. This guidance would be further impacted by any new U.S. tax legislation that is currently under consideration. Turning our attention to SG&A, you will note that in the second quarter SG&A including intangible amortization as a percent of sales was 14%, compared to 12.7% the prior year or 5.8 million higher. This increase was driven primarily by acquisition-related expenses of 4.2 million and 0.5 million of increased intangible amortization, resulting from our two auto-related acquisitions. Adjusting for these costs, SG&A as a percent of sales would have been lower at 12%, compared to 12.7% the prior year. We also had increased selling and administrative expenses from acquisitions increased investment in Dabir and higher travel cost. These increases were offset in-part by lower legal fees in the absence of expense related to our connectivity and AES reporting units exited in Q4 fiscal 2017. For the first half of this fiscal year, SG&A including intangible amortization as a percent of sales was 14.5%, compared to 13.5% one year ago or 8.5 million higher. This was driven primarily by acquisition-related expenses of $6.8 million and 0.5 million of increased intangible amortization. Adjusting for these costs, SG&A as a percent of sales would have been lower at 12.8% compared to 13.5% the prior year. We also realized additional selling and administrative expenses from acquisitions increased investment in Dabir and higher travel and bonus costs. These increases were offset in-part by lower legal fees of 2.4 million in the absence of expense related to our connectivity in AES reporting units. Moving to capital expenditures, in the first half we invested 16.4 million. We are revising our capital investment estimate to be in the $48 million to $52 million range up from our original guidance of 20 million to 24 million. There are a number of drivers contributing to this increase. With the acquisition of Procoplast and Pacific Insight there will be additional investment required to support their respective businesses, as well as support synergy initiatives with Methode. In addition, we are also purchasing a new building in India to accommodate our growing technology presence there. We are investing in a next gen Dabir controller to expand our presence in additional care settings beyond the operating room. And lastly, we will be increasing our capital investment to support current launches in our new business wins as reported on the previous earnings calls this year inclusive of this quarter. Expense for depreciation and amortization for the first six months was 12.9 million for fiscal year 2018 we expect depreciation and amortization to be between 28 million and 30 million. Shifting to EBITDA. This was 36.5 million for the quarter or 15.9% of sales. For the six-month period, EBITDA was 66.8 million or 15.5% of sales. As mentioned earlier by Don and disclosed in our press release, we incurred 4.2 million of acquisition related cost during our second quarter, and 6.8 million year-to-date. Adjusting for these costs, first half fiscal 2018 EBITDA would improve to 17.1%. Based on our fiscal 2018 guidance, we expect EBITDA to remain between a 135 million and 150 million or in the 15% to 17% range. Free cash flow for the six-month period was 41.1 million. Based on our guidance and higher capital investment I discussed previously, we expect fiscal 2018 free cash flow to be between 65 million and 75 million. Lastly, as we announced in the release this morning, we revised fiscal 2018 guidance for sales in the range of 880 million to 900 million from 807 million to 827 million, primarily due to the increase in sales resulting from the two auto-related acquisitions, Pacific Insight in the $50 million to $60 million range and Procoplast in the $16 million to $22 million range. Our European automotive segment is also contributing to the growth in sales, driven by volume currency and customer tooling and design fees. While we increased sales, we maintained our guidance for both income from operations and earnings per share. While both Pacific Insight and Procoplast are generating profit, this is largely offset by their associated acquisition-related cost and intangible amortization totaling approximately 10 million. Also, in offset to the flow-through from higher sales, we will be negatively impacted by foreign exchange, primarily the stronger peso, higher copper prices, and lower sales in our power segment. Don that concludes my comments.

John, thank you very much. Tim, we are ready to take questions. Q - Christopher Van Horn: Good morning. Thanks for taking my call.

Good morning, Chris.

I’m hoping you could give us some perspective on how the acquisitions came about, any sort of level of synergies that you see in a dollar amount form, and then maybe what your vision is, now that you have these two companies as well as your legacy Methode products, what the kind of vision is from the pipeline, and what kind of products you are going to bring to the market from these acquisitions?

Sure. The acquisitions came about early from our team looking for acquisitions that filled out our product line, gave us additional access to current or prospective customers. I’ll talk about Procoplast, first. There we thought we needed a mainland Europe operating entity, some of the products that we manufacture are getting a bit larger, what we are doing for the active roll stabilization program, shipping those out of Malta or out of Egypt were more expensive than we have been on the continent itself. So, we are searching for that. We are also searching for customers that had a background or excuse me - suppliers had a background and complex insert molding that to - complex insert molding rather. That would help our lead frame business and Procoplast filled both of those. They are in close proximity of our customers, plus as I mentioned in the past, they are doing business with Bosch, Bosch has, they are a favorite supplier for lead frames, we were unable to penetrate that because Bosch had their two suppliers, and this allowed us to enter that and so that is one of the major synergies that we see there and since that time we have had very favorable discussions with the customer. And in both cases, Pacific Insight and Procoplast, we look to get those, you know it is to our standard operating margins and so we know there is synergies that we have to employ there and they are not going to happen overnight, but that is one of the things Methode does very well as to its lean manufacturing, and take cost out of the product. So, we anticipate that in the coming fiscal year. We will be the bigger synergies in those both entities that we understand, we understand they are manufacturing and so on. So, there is a little less of a learning curve that might be in some other acquisition. Pacific Insight was really the same story. We were looking for how to expand our product offering, particularly in lighting in the vehicle as we were doing center consoles, we realized we were now contracting with people like PI for the lighting and the names we got into overhead counsel that became even more important, and also looking for who has the best technology out there for LEDs and the associated drivers, and then in our opinion PI did, neither company were for sale. We approached them and PI allows us to fulfil the automaker's desires for a more synergistic or harmonious combination of the instrument cluster along with center console and now the overhead console and so the lighting for that becomes very important and really integral to the product offering. So that made sense for us and I have said on previous calls, it is - lighting in the vehicle is becoming or has become a very important sales tool for the automakers. So, for all those reasons both those acquisitions made sense.

Okay, great. Thanks for all the color. And then unless if my math is wrong, it seems like Pacific did pretty well during the quarter relative to what has been going on with production levels in North America, it seems like Procoplast actually was a little bit higher than we expected, is there any kind of mixed advantage within those companies that you saw for the quarter?

No. Some of it - we don't have a lot of trend data, so it is hard to answer that, but there was nothing that stuck out that really changed from our initial projections in order doing the due diligence on it. So, I would say no. I think as we get some more quarters under our belt with both of these we will be able to answer that a little bit better.

Yes, and I would also comment they are limited data points. I mean Pacific Insight just represents one month of the results, while Procoplast is three months.

Yes, make sense. And then final for me, a lot of OEMs have been talking about challenging production environment going forward, are you using IHS for your expectations, for your guidance, and if so, or if not, what are your kind of expectations there heading into the back half of your fiscal year?

We tend to use LMC and may be double check with IHS a bit, but we also have the advantages of our releases from the automakers. I would say in the past three months is usually pretty good data, six months gets a little more fuzzy, but between those data points and our releases and that is really how we derive our guidance. There has been huge reports on - sales have been down year-over-year, but I would point out that Methode has launched one - last year the I700 for Thailand and Brazil. So, we are seeing the benefit of that being at full launch now this year and then we are launching the D2 terrain rain and so that’s in pipeline. So, we see the benefit and we have seen the benefit of increased sales in Europe. So, overall if you look at the U.S. numbers they are showing down our slight growth year-over-year when you take out the acquisitions they are really attributable to that.

Okay, great. Thanks very much. I’ll hop back in queue.

Sure, thank you.

Our next question comes from the line of David Leiker of Robert W. Baird. Please proceed with your question.

Good morning. This is actually Erin Welcenbach on for David.

Good morning, Erin.

My first question is, again, following up on that automotive segment, certainly strong growth even excluding the acquisition, you talked a little bit about stronger European growth, maybe if you could dig into a little bit more if there are any specific platforms driving that strong organic growth.

We’ve had a number of smaller launches in hidden switches, and then also the ergonomic switches, I don't have the exact date in front of us, but they have been - were now some of the premium vehicles, we have had launched it for, but also as we pointed out in our prepared remarks, we had design fees or tooling fees from the premium auto makers and so that when the volume there is not necessarily commensurate with the Ford of Europe or Fiat or Renault, but it is a good contributor of profit. John, do you have anything to add?

No. I think the only although contributor we have been helped by currency as well.

Yes.

Okay. Great. And then, I guess, just transitioning to acquisitions. Given the headwind from acquisition costs in the quarter, how should we be thinking about those costs abating over the next couple of quarters?

Well that’s highly dependent on acquisitions that we would pursue going forward. As we mentioned on the past, I would say now three calls where we continue to be very aggressive in terms of looking at our pipeline and pursuing targets that are of interest to us. So, highly dependent upon that.

And Erin to circle back on your question on Europe. The major program that launched and that is contributing is the Renault HVAC program that goes over several platforms in that launch and that contributed to sales as well in Europe.

Okay. Great. Thanks. And then one final question, just circling back in your long-term EBITDA growth targets, where are you on your targets for kind of that 9% to 10% annualized growth? And how much of that comes from organic versus inorganic growth?

We remain on target for our - that 9% to 10% growth, and as we have said in the past, it wasn't our last plan that tends any more backend loaded. We have announced a number of program wins for 2020 and beyond. So, we see those occurring that gives us optimism in that and I shall point out, I had current automotive volumes if there was a downturn that would certainly reflect in numbers. And then also, our Dabir product is in that not widely, but we do need that product to contribute, as well as our non, other non-automotive, our 10 gig products, which we are seeing a progress on. Our cloud computing product as well. So, we remain optimistic on that. Again John, if you have anything?

No, I mean not. I guess the only other product category that comes to mind is 10 gig. We are seeing some nice growth relative to 10 gig and there is some other emerging technologies in that segment that we think hopefully will surface in 2020.

I would also point out, we are pleased that we are now booking business again with Whirlpool and those are our - it was a $14 million program I talked about that we announced at the end of fiscal 2017, and now we just, I think it was 8 million this quarter. So, those are very nice wins and at one point, a year and half, two years ago, we weren't quite sure if that was going to continue. So, we are very pleased with that as well.

Great. Thanks for taking my questions and congrats on a nice quarter.

Thank you very much.

[Operator Instructions] Our next question comes from the line of Steve Dyer of Craig Hallum Group. Please proceed with your question.

Hi guys, this is Ryan Sigdahl on for Steve.

Hi, Ryan.

So, piggybacking off of a previous question, but you talked about several synergies that benefit MEI space businesses, but looking at it from the other direction, are there potential revenue synergies, and how easily can Procoplast Technology and products be crossed sold I mean as customers?

Quite well. Because they are - they are position insert molder and I differentiate between shoot and shape insert molding versus precision where do you have got to hold very tight talent as there is not a lot of companies in the world that can do that well to automotive quality, Procoplast does a very, very good job of that. Generally, on smaller products and were Methode tends to, our insert molding tends to be largest, we can cross pollinate our larger assemblies in the areas like Bosh that we talked about, and then vice versa some of their automation in some of the smaller areas that may be in the past, we have not ___ we did not want to mix large frame products with smaller frame products. So, there is quite a bit that we should see there now. Having said that, that’s not something that happens next year because we are technically booking business for 2021 and beyond now, but those opportunities certainly exist. And I will answer the same way on Pacific Insight. They are selling to people that are looking at producing overhead consoles or automakers, are adding it to it where we can come in essentially eliminate a supplier or two. And then part of our - and we didn’t build it into our financial models, but the synergies between the both or all three companies I think are great. I don't think there is synergies between Procoplast, Insert Molding, and PI, but to metal base business are very much so.

Great. And then secondly, maybe I missed it in your prepared remarks on the adjusted metrics you are given, but what was gross margin, excluding purchase accounting entries, and then secondly kind of on top of that, when do you expect margins to normalize after those adjustments have flowed through the P&L?

So, in the prepared remarks, we did not speak to normalized gross margins and we would really be primarily talking about a purchased accounting adjustment that was smaller in stature relative to the acquisition-related costs that we did call out.

Got you. Okay. And just to kind of follow-up there is no lingering affect kind of going into this quarter and those purchasing accounting where it would be, you know material enough that we should factor it in?

No, there shouldn't be any more still going through the valuation at this point in time. The intangible amortization that we are reporting is based on an estimate, but we are not expecting any material change when we complete those valuations.

Okay. Then lastly, can you provide an update on our next-generation F-series, any indication whether they are leaning towards a sole source award or if it is in their integrated center stack will be broken up between many suppliers and…thanks.

I really can’t because that would be bumping into our NDA with our customers. I can tell you that that’s not something that Methode is going to participate in though.

Did you say you will not be participating in it?

That’s correct.

Okay. Thank you.

Thank you.

There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to management for closing remarks.

Tim, thank you very much. I will conclude by wishing everyone a very safe and pleasant holiday season. Good day.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.