Don Duda - President & CEO John Hrudicka - CFO.

Joe Vruwink - Robert W. Baird.

Welcome to Methode Electronics Fiscal Year 2018 First 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 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 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 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, volume, quality and cost of new program launches; ability to withstand price pressure, the successive Procoplast and/or our ability to implement and profit from new applications of the required technology, currency fluctuations, customary risks related to conducting global operations; ability to successfully market and sell Dabir Surfaces; continued economic challenges in Europe including the exit the of United Kingdom from the European Union; 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; location of a significant amount of cash outside of the U.S.; ability to keep pace with rapid technological changes, a breach of our information technology systems; ability to avoid design or manufacturing defects; ability to compete effectively; ability to protect our intellectual property; 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 any material modifications to NAFTA and other international trade agreements.

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

Thank you, Sherry, and good morning, everyone. Thank you for joining us today for our fiscal 2018 first 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.

As I commented in our press release this morning, we made significant progress during the first quarter on the acquisition front; the completed acquisition of Procoplast will expand our customer base within European automotive, as well as our opportunities and sensors.

Additionally, with an anticipated closing in our second quarter we believe Pacific Insight, innovation and technology in LED based ambient and direct lighting with expand our presence within the automotive interior, as well as augment our efforts in overhead council and other areas of the vehicle.

We also believe there is potential to bring their technology and expertise to our non-automotive customers.

Until the acquisition of Pacific Insight is completed we remain obligated under non-disclosure provisions and security laws do not discuss any information about the company or the transaction except as already disclosed in the press releases or in other publicly available information.

And it is especially important that we carefully follow those obligations while the court and shareholder approval process is proceeding in Canada. We encourage you to visit Pacific Insight's website to learn more about the company and their technologies and products as I am unable to take questions.

Now moving on to review our financial results; year-over-year fiscal 2018 sales increased 4.8% in the first quarter. However, earnings per share decreased to $0.55 from $0.57 due to several factors. In the fiscal 2018 first quarter we incurred acquisition related expenses of $2.8 million related to the Procoplast and Pacific Insight's transactions.

Additionally we experienced higher new product development cost in the automotive segment of $1.7 million related primarily to the launch of Q1. We also invested an additional $0.9 million in sales and marketing, clinical resources and professional services for Dabir.

We added Vice President of Sales and Marketing and achieved clinical officer and continue to grow our relationship with Boston Strategic Partners.

Additionally, the first quarter of last year benefited from the commodity pricing adjustments of $1 million and one-time reversal of accruals related to customer commercial issues also valued at $1 million, both in the automotive segment.

Finally, fiscal 2018 first quarter earnings were negatively impacted by higher bonus expense of $1.4 million, higher stock award amortization expense of $0.6 million and unfavorable commodity pricing in the automotive and power product segment of $0.5 million.

Partially offsetting these factors were higher sales in the automotive and power products segments, lower legal fees of $1.7 million, lower income tax expense from $1.2 million, and a favorable currency impact on certain labor and factor expenses in the automotive and power product segments, mostly attributable to the RMB.

Compared to last year's first quarter, consolidated gross margins declined 60 basis points driven mainly by the new product development cost in the automotive segment, lower sales volumes and unfavorable sales mix in the interface segment and unfavorable sales mix and unfavorable commodity pricing in the power product segment and the absence of commodity pricing adjustments and reversal of customer commercial accruals in the automotive payment in fiscal 2017 first quarter.

These were partially offset by higher sales in the automotive and power product segments and a favorable currency impact, again, mainly the RMB on certain labor and factory expenses in the automotive and power product segments. Year-over-year, selling and administrative expenses increased in fiscal 2018 first quarter.

We did experience lower legal fees and reduced expenses related to connectivity but those were offset by the M&A expenses; higher bonus expense, the increased investment in Dabir and higher stock award amortization expenses. Year-over-year, fiscal 2018 first quarter operating income was $25.4 million compared to $26.7 million last year.

As previously mentioned during the first quarter the company incurred $2.8 million of acquisition related expenses. First quarter operating margin was 12.6% this year compared to 13.9% in fiscal 2017 first quarter.

Now moving on to review of our segment results; automotive segment sales increased 6.4% in first quarter compared to last year due to higher sales of integrated center panel and steering wheels with products in Europe; General Motors' center consoles, linear position sensors, and transmission lead frame assembly products.

These improved sales were partially offset by lower customer funded tooling and steering angle sensor product sales.

Year-over-year automotive gross margins declined to 29.3% from 30.2% due to the development cost for new products on favorable commodity pricing and the absence of the commodity pricing adjustments in onetime reversal of accruals related to customer commercial issues which occurred last year.

Or these decreases were partially offset by higher sales and a favorable currency impact on certain labor and factory expenses. For fiscal 2018 we are targeting automotive gross margins at mid to upper 20% range.

Moving to Interface; year-over-year segment sales decreased 10.6% in the first quarter driven mainly by the exit of connectivity, lower plant sales due to much lower than planned service parts revenue, lower data solution product sales in North America and lower legacy product in Asia.

These decreases were partially offset by the improved radio remote [ph] controlled sales in North America and Europe. Compared to last year, interface gross margins declined to 21.8% from 23.7% in the first quarter negatively impacted by lower sales and unfavorable sales mix of appliance products.

For fiscal 2018 we are targeting interface gross margins in the high-teens to low 20% range. Hetronic litigation costs were $2.5 million in the first quarter versus $4.3 million last year. The bulk of these expenses were related to discovery costs and depositions with respect to the litigation with the former distributor.

In fact, discovery in the case is actively progressing, and is expected to be concluded by the end of October. Any of these positive motions would follow-on early 2018. We anticipate Hetronic litigation costs to be $6 million in fiscal 2018, but depending on events may approach last year's level.

To reiterate, we believe it is critical that we protect the Hetronic brand, prevent unfair competition, and protect our path to market in the industrial space which is a key component to our five-year growth plan.

In our power product sales increased year-over-year by 26.7% in the first quarter due mainly to higher Bypass Switch [ph] and busbar volumes.

Year-over-year segment gross margins in the first quarter declined to 27.6% from 28.3% due to an unfavorable sales mix and unfavorably commodity pricing, partially offset by the higher sales volumes and a favorable currency impact for labor and certain factory expenses.

Regarding the unfavorable sales mix in the first quarter, we experienced increased sales through our military aerospace customers, lower sales to our cloud computing customer. Mil aero sales typically carried lower margins mainly because they must be produced domestically.

As we indicated in last quarters conference call, our cloud computing customer took those [ph] product than originally anticipated, they have informed us they anticipate resuming to their prior ordering levels about mid-third quarter. For 2018 we are targeting power products gross margin in the mid-20% range.

As we indicated in the release this morning, Methode anticipates fiscal 2018 sales in the range of $807 million to $827 million, income from operations in the range of $114 million to $127 million and earnings per share in the range of $2.43 to $2.63.

This guidance includes nine months of Procoplast projected results but excludes results from Pacific Insight as the transaction closing remains subject to customary closing conditions including approval by Pacific Insight shareholders.

The guidance ranges from 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.

Moving to new business wins; in our automotive segment we were awarded an extension of our linear position sensor program through our fiscal 2022 with average annual revenue of $16 million. You may recall this product utilizes our magneto elastic technology.

It is important to note that sales of products utilizing our magneto elastic technology will approach $37 million in our fiscal 2020. Additionally, we were awarded a reflected LED alert display or RLED for North American OEM for both the North American and Asian markets.

RLED consist of LEDs that flash and reflect off the windshields and the driver feels the vision when a potential frontend collision is detected. This initial award is for approximately $3 million in revenue per year and will launch in our fiscal 2021.

We believe this award is in the rapidly growing advanced driver assistance field along with our capabilities and know-how in integrating electronics and lighting, it will provide us a platform to pursue other OEMs in the safety segment.

We were also awarded an additional integrated tailgate module program with another North American OEM strengthening in our position with this customer and our stature in this category.

Launching in fiscal 2021, this win represents average annual revenue of $2 million but more importantly, brings our total business with this niche product to nearly $7 million. In Europe we're awarded various programs for Ford, Aston Martin and McLaren with combined average revenue of $4.5 million beginning in fiscal 2020.

Our European operations also awarded additional eBike business with Bosch for approximately $10 million in revenue beginning in our fiscal 2020. Finally, our power product segments was awarded busbar's for the U.S. Navy nuclear [ph] submarine program beginning in fiscal 2019 for approximately $2.5 million in annual revenue.

Overall, in Methode's first quarter we booked approximately $22 million in new annual revenue. Now let's move on with an update on Dabir. Our success in the surgical arena continues without a single pressure injury reported to-date.

The teaching hospital we have referenced in the past has submitted their initial findings to symposium on advanced wound care and has received a highest score for all of the abstracts comprising the clinical research section of their upcoming conference in October.

For this achievement the lead author will be presented with an award at the conference. We continue to work with several hospital systems across the United States who now have a strong interest in the Dabir product as a result of our successful clinical trials.

As I mentioned a moment ago, we have added several healthcare professionals and with their expertise have been able to penetrate deep within these hospital systems by engaging established high level relationships at multiple sites and departments.

Additionally, we are seeing a conservative amount of interest in the ICU and currently have trials in that care setting. This approach is a result of our work with Boston Strategic Partners and these new healthcare professionals. We have targeted at least three healthcare systems for conversion to Dabir within the next 6 to 12 months.

These are major institutions that upon adopting Dabir would provide the jumpstart needed to propel the product to a standard-of-care while protecting thousands of patients from preferred injuries. Now, I will turn the call over to John, who will give further details regarding our financial results.

John?.

Thank you, Don. I have just a few brief comments on the quarter. Good morning, everyone. Before I begin with my commentary, I want to clarify that my comments exclude any impact to Pacific Insight as the transaction closing remains subject to customary closing conditions including approval by Pacific Insight shareholders.

So let's begin with the effective tax rate, for the quarter was 17.1%. This was down from fiscal year 2017 and below our current fiscal year 2018 guidance range, primarily due to a couple of discrete tax adjustments made during the quarter.

We recorded a benefit associated with the fair value write-up of our deferred tax assets related to the recent increase in the State of Illinois corporate income tax. The other favorable tax adjustment was related to the new accounting rules for stock-based compensation.

This guidance requires the tax effects related to share based payments to be recorded through the income statement as opposed to paid in capital. While at the low end of the range excluding these adjustments our effective tax rate would have been within our full year guidance of low to mid-20s that is still expected for fiscal year 2018.

Turning our attention to SG&A, you will note that in the first quarter SG&A as a percent of sales was 14.7% compared to 14% to prior year.

This was driven primarily by acquisition expenses of $2.8 million representing activity associated with the closed Procoplast transaction and due diligence supporting the Pacific Insight acquisition expected to be completed next quarter. Adjusting for these costs, SG&A as a percent of sales would have been 13.3% compared to 14% the prior year.

We also had higher bonus expense increased investment in Dabir and higher stock award amortization expenses. These increases were offset in part by lower legal fees of $1.7 million and the absence of expense related to our connectivity and AES reporting units. Moving to capital expenditures; in the first quarter we invested $8 million.

While the first quarter run rate is on the high side, we still expect for fiscal year 2018 capital investments to be between $20 million and $24 million. Expense for depreciation and amortization in the quarter was $5.6 million. For fiscal year 2018, we expect depreciation and amortization to be between $20 million and $24 million.

Shifting to EBITDA, this was $30.2 million for the quarter or 15% of sales as mentioned earlier by Don and disclosed in our press release, we incurred $2.8 million of M&A cost during our first quarter. Based on our fiscal 2018 guidance, we expect EBITDA to be in the 16.5% to 18.5% range or between $135 million and $150 million.

Lastly, free cash flow for the quarter was $18.1 million; based on our guidance and capital investment estimate we expect fiscal 2018 free cash flow to be between $90 million and $100 million. Don, that concludes my comments..

John, thank you very much. Sherry, we are ready to for questions..

Thank you. [Operator Instructions] Our first question is from Christen [ph] with FBR. Please state your question..

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

I just wanted to dig into your auto exposure a little bit because a lot of your customers are talking about production cuts in the back half, I'm curious if how you look at the industry if you use IHS as kind of a baseline and then kind of add some growth to that because you've seemed to be able to outgrow what's happening in the production world.

And then along those same lines have you looked at kind of your passenger car versus SUV and truck mix and would you be able to disclose that?.

In the United States we are primarily in truck and SUV, so pass cars in general have been reported as being down and both from -- we'll use FMC and then we double check I think at times with IHS. But as our customer has reported, they expect relatively robust sales for the second half in truck and SUVs, and in particular, I think at SUV.

So that has helped us, we're up in the quarter just slightly over our own expectations but we're not exposed to the pass cars.

Now when we get into Europe, that is a different story but we had also very good sales in Europe, so while -- I think we're all very cautious looking forward, we're not seeing anything that would change our view on certainly U.S. production..

Okay, got it.

And then on the Europe front, you know, the center -- it looks like center counsel had a very good quarter; was that one or two programs ramping up or is that just -- it was their good volume for the programs you had leveraged to?.

I'll have to check but I want to say it's our renewal business that -- I think somewhat got off to a slow launch that is hitting its stride now..

Okay, got it. And then on eBike, correct me if I'm wrong; but I think you had mentioned $23 million by 2019 timeframe.

You have a new win today of around $10 million, so you're seeing a lot of good momentum there; have you've seen what the addressable market is for that and what's really driving -- is it mainly in Europe that's driving a lot of this business?.

It is mainly Europe and the eBike's are commonly known as -- I'm forgetting what -- [indiscernible], thank you. In the U.S. they can drive in the bike lane because they [indiscernible]. And I have driven one of the Bosch units and it is quite nice.

And so that's what's driving it, it's just economics and getting around in crowded European streets, so it's done very well for Bosch and we're seeing business with others. We are really the standard for the torque sensor in these bike so if you're going to trade one, you're likely to give us a call; so that's what's driving the business.

As far as the market, that's a hard one to put the numbers around. I would say Bosch is the leader followed by a number of smaller companies and then there is also a Chinese component to it as well. I'd be at a loss to really say is that -- it's not a huge market so it's very much a niche market but it has served us well..

Okay, great..

But I will also say it's probably a little more volatile than what we might see in automotive..

Yes, I'd imagine that. And then just one more for me and I'll hop back in the queue but it seems like the investment in the sales channel for Dabir is ramping here.

Is there any update on the timeline or kind of your financial goals in terms of revenues for that product that you're willing to share?.

We expect -- I'm not going to give the exact number but we have in -- in our guidance we have Dabir revenues forecasted and income from that. And I should say that probably represents biggest risk to us and that it's difficult to predict exactly when these hospitals will provide purchase orders.

But we have charged the teams, they are incentivized to turn revenue this year and we remain I think very optimistic but as we said before it is very difficult to predict when these hospitals are going to move.

We have one hospital in California that the contract has been in their legal revenue for three weeks now, so I know nothing is going to happen until that's complete and we are not to hold up there. So again, I'm optimistic but we're near -- close to it but we're not there yet..

Okay, thanks for the color..

Thank you..

[Operator Instructions] Our next question is from Joe Vruwink with Robert W. Baird. Please state your question..

Hi, good morning. Can you maybe give us an update on your strategy targeting the interior of the vehicle? Obviously, it seems like you began with the Center Stack. It's been broadening outward new books and business and overhead consoles, LED lighting is going to give you another element.

You've picked up some business organically and obviously you are investing there. So, it seemed like you are getting feedback or you are seeing an opportunity to expand your reach in the cockpit.

And I am just wondering if you could maybe explain why this opportunity has come about and then size the opportunity? What revenues could ultimately be generated?.

Okay. Let's start with the overhead. That's a natural extension of what we do and there is more electronics going in there. And I think at this point what I should say is that we're not going to become and interiors company here. Let's make that very clear.

But where there is electronic content in the vehicle, we will examine whether we want to participate in that. RLED is an example and that's the safety area, but it's in the instrument cluster area. So logically we will move up in the vehicle to center consoles and over to the instrument cluster.

That's not to say Joe that we're going to start making clusters. That's not something that we're targeting at the moment. But when we do see that area changing and we do see that the center console is going to in potential designs will be integrated towards the instrument cluster.

When that starts to happen then we get very interested in that, because that starts to look like one module. So those are the areas that we're concentrating and it's just a logical extension of what we do. We're using same engineering recourse at the same factory operations that we do for the center consoles in the overhead.

So, it makes sense to us, and like anything that we look at some of the areas are not going to approach our target at the margin levels. So, we will cut [ph] on that.

But whether let's significant electronic content, where we can use our engineering and our manufacturing expertise and our technology, we're going to look at and that's what you are seeing. And also, our customers are more confident in us today than when we started with K2 many years ago. So, they are willing to let us look at other areas.

I think RLED is a good example of that. That's not a huge win for us, but that area is going to grow and I was pleased with the customer confidence in that. Where that can go and in revenues, I'll stick to our stated goal and our proxy [ph] on 2020 and realistically most of what we're booking today is going to be behind that.

But as you look at the center console market for trucks and SUV's there is a good portion of them that have overhead. So that market is not quite one for one..

And on LED lighting; can you maybe talk about just generically at a high level, why that specific product application? Obviously as I would imagine vertical integration on a lot of products you are already supplying but there it seems to be a nice revenue opportunity behind it as well?.

Yes. You hit the nail on the head vertical integration, which is what we always look at. And particularly when you get into overhead consoles there is a lighting aspect of it. But -- and if you look at a vehicle today, the number of light points in the vehicle are ever increasing. And ambient lighting is becoming a design focus.

I mean just go back four five years and it was maybe on some of the higher end vehicles but it's very common today and if we're all about going to our customers and saying, you can get that completely from us; we can do the center counsel, we can do the overhead counsel and we can provide you the lighting and much of the modules in the vehicle are very similar.

So what you might put in overhead, you may put in a door panel that we wouldn't but the automaker or its interior supplier would. So to us it's just a logical extension of our product..

And then I know you're only one quarter into your fiscal year and you're reaffirming guidance but is it may be possible directionally to say whether you're tracking towards the high end of the range or maybe how much more confident you are relative to a quarter ago in achieving guidance? And the reason I'm asking it this way is, it seems like in Q1 there were a lot of costs that certainly we weren't explicitly modeling, particularly around the acquisition cost and it would seem like into the back half of this year a lot of these things are maybe said to subside which would seem to imply the first half of your fiscal year was really where maybe the earnings variability was going to come in and things in the second half are said to be much more tailwinds for Methode as opposed to have once?.

I suppose that's -- you could look at it that way. I was trying to answer the questions but I think that's when I think I will stick with my guidance comments or reaffirming guidance a few minutes ago.

I will point out that the first quarter came in pretty much where we expected it to and when we modeled our quarters, there were -- there is always ins and outs but its pretty much was spot-on to what we expected slightly higher in revenue but nothing that would cause us to want to change our guidance ranges.

So that's probably the best answer I can give you..

Just one more and I'll turn it over.

But is it fair to think that almost $3 million in acquisition costs and given the timeline around the Hetronic litigation, legal is probably last so I'd imagine $3 million in acquisition cost probably don't continue at that quarterly pace and current legal spending probably doesn't continue at the quarterly pace through the entirety of your fiscal year?.

Legal could go up, I made the comment in my prepared remarks so I don't know that I would say that that could necessarily go down, it really depends on how the case goes. I don't -- Don, if you wanted to….

Well, I guess the other comment I would make is in relation to acquisition cost, I mean last quarter I think we sent a pretty strong message that we were going to be very inquisitive and aggressive relative to acquisitions.

Now with that being said, the timing of when we recognize those expenses and targets that surface related to expense is something you can't predict readily but I would not conclude that first quarter the M&A expenses that we incurred is the last of what you're going to see for the full year..

Okay, great. Thank you..

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remarks..

Sherry, thank you. We'll conclude and wish everybody a very safe and pleasant Labor Day weekend. Thank you, everyone..

This concludes today's conference. You may disconnect your lines at this time and thank you for your participation..