Welcome to Methode Electronics Fiscal Year 2017 Second Quarter Earnings Conference Call. [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 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, quality and cost of new program launches; ability to withstand price pressure, including pricing concessions, 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 of the 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, cost and expenses due to regulations regarding conflict materials; and the effect of the Presidential election on 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, Melissa and good morning everyone. Thank you for joining us today for our fiscal 2017 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 second quarter fiscal 2017 sales increased slightly, but decreased on the 6 months by 2.6%. Net income increased in both periods affected mainly by favorable commodity pricing of raw materials and a favorable currency impact on material and labor expenses; international government grant, which I will talk more about in a bit; overhead cost reductions in our Power Products segment and lower travel expenses. Partially offsetting these factors in both periods were increased stock award amortization expense and higher legal and other professional fees, particularly related to the Hetronic litigation. Second quarter net income was also positively impacted by high automotive and power products sales partially offset by unfavorable data solution sales. In the first half, net income also benefited from lower income tax expense, commodity pricing adjustments and the reversal of a customer commercial issue in the Automotive segment as well as the absence of the cost associated with the move of manufacturing from the Philippines to Egypt we experienced last year. These first half benefits were partially offset by lower sales and the absence of a tariff refund. Compared to last year’s second quarter and first half consolidated gross margins as a percentage of sales improved 220 and 190 basis points respectively positively influenced by favorable commodity pricing and favorable currency impact on materials and labor as well as overhead cost reductions in Power Products segment. The first half was also positively impacted by the commodity pricing adjustments and the reversal of a…

Thank you, Don. I have just a few brief comments on the quarter and six months period. Good morning everyone. The effective tax rate for the six months period was 20.2%, nearly flat to our Q1 rate of 20.6%. At the low end, this remains within our guidance range of low to mid-20s. As Don mentioned earlier, we purchased slightly more than 280,000 shares of stock this quarter at an average price of $34.96. Inception to-date, we repurchased 2.3 million shares for a total of $71.8 million. Turning our attention to SG&A, you will note that in the second quarter, SG&A as a percent of sales was 12.7% compared to 11.8% the prior year or $2 million higher. This was primarily due to an increase in the stock award amortization of $1.5 million. This increase is due to minimal amortization in the second quarter of last year due to the grant of 2015 awards not occurring until the second quarter, resulting in only one month of amortization. For the first half, SG&A as a percent of sales was 13.5% compared to 11.6% the prior year or $6.4 million higher. This was primarily due to $4.8 million in higher stock award amortization just mentioned and $3.1 million increase in legal fees, offset in part by lower travels. I would like to talk to you about our credit facility just for a moment. You may already be aware, but on November 18, we executed a new credit agreement. This agreement contains a maximum principal amount of $150 million, with an option to increase the principal amount by up to an additional $100 million subject to customary conditions and approvals. This represents an increase of $50 million to both principal and the option respectively when comparing to the previous agreement. Our base variable interest rate is 25 basis points lower than the previous agreement. This new agreement expands our liquidity and provides additional flexibility to support our future strategic initiatives. Moving to capital expenditures, in the first half of fiscal 2017, we invested $9.5 million. For the fiscal year 2017, we expect capital investment to be between $18 million and $22 million. Expense for depreciation and amortization for the first 6 months was $11.7 million. For fiscal year 2017, we expect depreciation and amortization to be between $23 million and $25 million. Shifting to EBITDA, for the 6-month period was $69.4 million or 17.3% of sales. We expect EBITDA to be in the 16% to 17% range or between $126 million and $141 million for the full year. Lastly, free cash flow for the 6-month period was $48.1 million. Based on our guidance and capital spending estimate, we expect fiscal 2017 free cash flow to be between $83 million and $92 million. Don, that concludes my comments.

Thank you, John. Melissa, we are ready to take questions.

Thank you. [Operator Instructions] Our first question comes from the line of Christopher Van Horn with FBR & Company. Please proceed with your question.

Well, this is Dan Drawbaugh on the line for Chris. Hi, guys and congrats in the quarter.

Thank you.

Thank you.

I would like to start on automotive. So, I was wondering if there is any sort – any new business that’s been wondering the quarter. I apologize if I missed anything on the call or if you could update us on any of the recent wins you announced last quarter just how those are progressing?

Okay. There was nothing significant during the quarter. We always have smaller programs that come in, but we generally just mentioned the larger ones and we didn’t have anything this particular quarter. The awards from last quarter, those will progress their normal, I guess, launch routine. We are just getting started on those and they will launch over the next 18 to 24 months. There has been talk about some of those expanding in other platforms, but nothing we could announce now. F-150, we generally don’t comment too much because that’s going to be a competitive bid, but that’s progressing the way we would expect it to, nothing to really talk about there, but that it is on the horizon for next year.

Okay, thank you for that. And on Dabir, I was curious when you say that you guys are going to be spending a little more, perhaps $8 million rather than $7 million. Could you give us a sense of how each dollar of incremental spread can impact your capacity? How quickly can you ramp volume in the future to meet demand?

Sure. Good question. Because we are manufacturers, one of the things that we learned a long time ago is you build enough capacity for any potential upside. So, our manufacturing system hopefully would max it out, but we have enough capacity built in to the system, I think for any short-term increase in volume. So, I am comfortable. The spend really is in sales and marketing more medical sales personnel, but also – and I think what we took away from the symposium I talked about and I have to congratulate the Dabir team. That was – it was extremely impressive the number of people that were there, the quality of the people represented were just fantastic. And we will spend additional money – and really as a result of that on personnel, but also to educate, what we are finding, once hospitals come to grips, they have a pressure ulcer issue. It takes a while for them to say, well, where does it start? It can’t be in OR, because we haven’t seen any. Well, in one recent surgery, you may not see it right after surgery, but it may happen maybe in the hospital room or at home. So, there is an indication process that has to go on some hospitals such as these teaching hospitals, is well aware of where the pressure ulcers occur. So, we are finding ourselves having to do more education and that takes, I think a little bit of a different sales person. It takes more nursing personnel. So, that’s where we are spending maybe additional money. And that certainly will result in higher sales. And then we have the capacity for that. And then also as I talked about our Gen 2 product, which is geared to more the skilled nursing facilities where there is actually a bigger market there than there is in the hospitals. So, that’s what we are spending the money. And like as I said, we will spend more money next year as needed, but we also want to see sales materialize. And as I mentioned, if all the trials turn into product sales, that’s a little under $3 million and we continue to get request for evaluation. So, things are starting to move just slower than we would like.

Got it. Thank you. Then 6,000 surgeries, bit over that, I guess, can you talk a bit about how maybe unit volumes are? I think last quarter on the call, you mentioned that it was somewhere over 100 units, can you clarify how that may have changed since you last talked about it?

We can get you that data. I don’t have it in front of me. The number has obviously gone up, because there is more evaluations going on. And the 100 number would likely be the number of controllers out there, because of the surfaces that would be a larger number, but we can get you that number. We just don’t have it in front of us. I don’t want to guess.

Okay. No problem. No problem. I will go ahead and jump back in queue. Thank you, guys for the color.

Thank you, Dan.

Thank you. Our next question comes from the line of Steve Dyer with Craig-Hallum Capital Group. Please proceed with your question.

Hey, it’s actually Greg Palm on for Steve. Good morning.

Good morning, Greg.

I was hoping you could start by addressing the weakness and interfaced a little bit more. And then kind of longer term in the past, you have talked about letting that appliance business kind of run off, but you have got this persistent weakness in Hetronic, obviously, some longer term headwinds within data. So, just kind of curious what the strategy is with this sector longer term?

Sure. Very good question. Data is a little bit of a double-edged sword. What we lose on the data solutions or apparatus business, we tend to gain in power because of the PowerRail product and that’s starting to ramp and that’s on our projections for the year. And that does carry higher margins. So, if I had to have, I would like both, but if I had to have one down, I would take the apparatus business. What we are going through now is – and I have said this a couple of times is probably a new norm in data centers as people move to cloud computing. I mean, Methode’s evaluating, do we needed to buy a new box or can we move to the cloud and – so we are evaluating everyone else is. So, that is causing our big customers, RackSpace, Hitachi Data Systems to be way down in their business. I think that’s going to continue. That’s one of the reasons we have made the comment on revenue guidance and on release and in our prepared remarks. So, we are coming to terms like how do we deal with that business. We are still very excited about 10-gig and that’s also part of that group that materialized slower. And I mentioned that HP finally launched their platform, but a year later. So, there is some good news on the horizon there, but I think the apparatus side is likely to remain down and we will have to just review that business and that’s what we do as a management team. On the Hetronic side, of late, while haven’t seen it necessarily in significantly increased revenues, but we see more opportunities. That group now is fully integrated in the Methode and the Methode manufacturing. So that will…

That’s interesting color. Just in terms of the data solutions, would there ever be an opportunity for some sort of divestment or would a potential future of you be more along the lines of the restructuring or something like that?

We always take actions to try to get our expenses in line with our sales. And so those are ongoing. Any dramatic action is something you take very carefully after a lot of thought and you can’t rule those out. I mean that’s we have done it in the past. But I think at first, what we are doing here is just taking stock of where the business is. Data centers aren’t going away. And we have seen before where enough people in the market has caused our customers to stop spending. It is capital spending. It can’t go to zero. We saw that with PowerRail a year ago. Auto, there can be a downturn in auto, but you are still going to shift a certain amount of product. Capital spending can go to zero. And we have seen that I guess I believe in the past. So I don’t want to react too dramatically, but we do think we are at the point where we have to make certain adjustments. And those are ongoing. But to answer your question, I don’t rule any of that out. That always comes into our thinking.

Okay. Shifting gears to auto kind of looking forward, I think GM is going to be changing over from K2 to T1 at some point either next year or early ‘18, so can you just remind us the timing there and how we should be thinking about the impact as it relates to your fiscal year ‘18?

That’s one I can’t answer because it’s really – it’s when the customer announces it. We certainly are privy to that, because we have to prepare for it, but our agreement was with our customers. We can’t discuss it. There is data out there on and there is LMC data and IHS data, but we really can’t comment on when that transition would take place.

Okay, fair enough. On Dabir congrats on the continued momentum there, I guess first question, can you maybe talk a little bit more about kind of the revenue ramp, you mentioned the $3 million, but maybe sort of when that could inflect to a material amount. And then in terms of building out sales and distribution for that product, kind of where are we?

Yes. Let me answer that one first. We still believe that ultimately, Dabir gets to the hospitals through some sort of association with our distributor. But we need to have that momentum going before that really makes sense to us and to the distributor. And I think ultimately, the hospital will dictate who they want to buy it from. So we continued to, I guess have discussions with potential resellers, but we are still in the mode of kick starting Dabir, which requires our own sales efforts. And from that, we learned quite a bit and we will continue to add support staff as necessary as part of the spend and also really in educating the customers. And one of the points I didn’t make in my prepared remarks, but it’s only been a little better than a year that the government has said they are not paying for Medical Never Events. That was 2015, I think is when they announced that. And pressure ulcers were included in that. So it is the hospitals now are just starting to say okay, this is costing us money and causing litigation and probably more importantly, insurance companies are starting to get involved. So the education process, I think is something that we need to concentrate more on. At what point does it become meaningful revenue, I have said in the past, I would believe that’s a fiscal ‘18 event. We have got enough – we got almost $3 million worth of evaluations going on now. I would expect the majority of those to convert. But we are going to have to wait and see how the next several months develop. We have three paying customers now. We have a major Midwest hospital that we would believe would convert probably mid next year after their very extensive trials are concluded. So it will be next year. It’s very difficult to give the timing of that.

Okay. Just lastly, housekeeping item, on the EPS, does the revised guidance take into account any additional potential benefit from government grants, I think you mentioned $3 million, or would that be upside?

No, that is included in that because it is worth maintaining headcount. And so we can project that we are able to maintain it and there should be no reason we won’t get that.

So to be clear, there is an additional $3 million included in the revised EPS guidance?

Correct.

Okay, alright. Thanks.

Thank you.

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

Hi guys. This is Joe Vruwink for David.

Hi Joe.

I wanted to get your thoughts on a few topics and they kind of relate to the environment since the election, one is going to have to do with maybe better industrial spending, you have certainly seen some strong PMIs of late, so if you think about manufacturing managers just having more confidence in their business, that’s an environment that Hetronic hasn’t seen in years and so I am just wondering if there is any thoughts on kind of the industrial side of your business whether the next 12 months are demand inflection, that will be Part A. Part B of my question is just on cash repatriation, you have a substantial amount of cash overseas, if you could bring that back in an effective way, would you and are there things you are maybe contemplating spending on that overseas balance could be helpful with?

Let me answer Part B first, absolutely. If it made sense for us to bring that back, we would bring that all back obviously, but we would, we take advantage of that. That happened in ‘06, yes. And it depends on what the criteria. In ‘06, you had to, if I remember correctly, you just had to use it to pay American wages. So it depends on what the guidelines are on that, but if it’s feasible, we would definitely do that. As far as in industrial spending and Hetronic yes, that thought has crossed our mind that this could be very beneficial. But I like in it back to the shovel ready projects that in ‘08 that was supposed to help, that takes a long time. So is it going to have an effect six months from now, maybe I am being glass half empty here, but I don’t think so. But can it have an effect in the next 12 months to 18 months, yes I think it can. I mean, if they follow through on that, it’s a sector that’s been down for I believe probably go back to ‘08. And some of that is just that it was overspending and if you look at the machinery that was purchased back prior to that, some of that stuff is within its useful life. So it’s not going to recover until that really happens, but increased spending, increased military spending in that industrial, but that is something we have looked at too that could help our Power Products. And we have seen an increase, a slight increase in military spending and in particular, quoting activities. So post-election that – both of those could benefit from the President elect’s policy. But we will have to take a wait and see approach. And I have not read anything like maybe you have on repatriation. It was talked about, but I have not seen anything in the last – since the election specifically on it.

Yes. I think there is a few proposals out there and it’s a matter right now of which one wins out, but that’s helpful. Any idea how much Hetronic is off from its peak in thinking about how far revenues have declined, I know that there is the Europe distributor phenomenon that’s probably diluting the revenue base a little bit, but anyway to help us think about what that might contribute in potential revenue and earnings recovery?

We are looking that up right now, so let me – I will let Ron do his math. Do you have another question while they are doing that?

I do, switching over to the 10-gig transceiver, so the $2 million to $3 million in revenue, when you think about just getting that launched and then HP is kind of just getting launched, so $2 million to $3 million is almost – it seems to me almost a normal quarter’s worth of revenue, if everything was launched and you are generating at full speed, so is $2 million to $3 million, maybe I can annualize that and it’s $10 million worth of annualized business that I can model into next year, is that maybe too aggressive or is that the right thought process?

No. That’s the right thought process. And we are not into – or we are just about to go into budgeting for next year. We will have to look at that. Normally, I would say yes, that’s a good way of looking at it. I just want to see once we get through the labs on all these customers, what their take rate is before I get real positive about the $8 million, $9 million, $10 million of business from that. I mentioned it because it is a new product. We were expecting higher volume this year from it. It was slow to materialize, but it is – those sales are, to me are notable for a new product. So that’s why we mentioned it. And then to answer your question, Hetronic from its peak is down about 20%. And it is a very profitable business once we pass – get passed a certain inflection point. So that – it was in one of my prepared remarks, I think it was in response to the question. We are optimistic about that business. So we expect – one we expect we should succeed in our litigation and two, we should see – but let’s wait, Joe. I think we have seen the bottom in Hetronic and we have got efforts in new products that should get us back on track.

Okay. And then my last question, in thinking about the 5-year forecast and to be doing 9% to 10% EBITDA growth, how do you feel about those targets today, obviously you got to be in the low to mid-teens hereafter to still execute on it, there is a lot of puts and takes, the end market environment hasn’t helped you, this data solutions phenomenon hasn’t helped, just wondering if you are in a position to maybe give an update?

Sure, yes. The data solutions doesn’t help, but I think we are probably underestimated where Dabir can get to. So there is like you said, there is always puts and takes, but data is not necessarily helpful. But if you look at our last 5-year plan, it was back end loaded. You have to launch products, those products have to come up to speed. I don’t look at Dabir any differently than K2 and that once that got going, you saw a dramatic improvement not only in the revenues and obviously in our bottom line. I don’t think it’s going to be any different. T1, we booked that. We are in launch on that. So that there was a big – well, it doesn’t necessarily create upside and it could have created a large fall. And so T1 was a major milestone. So we are optimistic and our incentive plans are based on that as well. So we are optimistic that we will get to target on that. And yes, we have some headwinds, but we have had that in the past. And we will make the appropriate adjustments. But we have got a number of things going for us with Dabir. Hetronic will improve. I like what we are doing in interface from the vending and commercial food services. Those are not as higher revenue, but those are very good margins.

And I am concerned a little bit about Europe. But I think that – I think once everything settles down from Brexit and the U.S. election, I think we will see Europe stabilize. And there are some – I think you guys had to report that the auto sales were good, there is just enough still enough fluctuation there that we are still kind of going quarter-to-quarter. But 5-year plan, I don’t know, John, if you have any more comments on that, but I think we are where we want to be.

No. I think you captured it well. Dabir is obviously the wildcard. And as we talked earlier, we have a great deal of confidence in the product and coming out of the symposium, even more so. So, we are very optimistic.

Okay, great. Thanks, guys.

Thank you. [Operator Instructions] Our next question comes from the line of Jimmy Baker with B. Riley & Company. Please proceed with your question.

Great. Good morning. Thanks for taking my questions.

Good morning, Jimmy.

Most have actually been answered at this point, but I do have a couple of follow-ups. I will start with first on the F-150, are you far enough along to talk about how that’s being bid, in other words, if it will be a complete center stack less the screen or there could be parsed out further to multiple vendors?

For a variety of reasons, I can’t comment on anything what the customer is doing from one, from our agreements with the customer and also the competitive nature. So, I really can’t answer that one.

Okay, fair enough. The additional $100 million in borrowing capacity, again, I am sure you could say specifically, but is there any catalyst you could point to for that increase? Are you seeing larger deals in the pipeline or anything specifically where you want that flexibility?

I think John said its increased visibility. We said a number of times we are in the hunt for acquisitions and so on. I wouldn’t necessarily tie the two together. It’s just – it made sense. The board was in favor of it. The rate was less. So, it just gives us increased flexibility whether we want to do an acquisition or increase the stock buyback or some other activity. That’s really the flexibility is probably the best word.

Yes, I mean, the renewal was coming up next year in September. And so we decided to get ahead of it and be proactive. And I think on these calls as well as with investors, Don has talked openly about potential acquisition activity. And I think with Dabir, depending on the milestones and how they propel certain activity, whether it’s pulling demand or such, we are going to want to act timely in terms of further investment into this business.

Okay, that color is very helpful. Don, I know we have talked about this in the past, but just given the updated Dabir information, I want to revisit how you think about building awareness and distribution there. So, your management team is highly incentivized based on EBITDA and you just talked about getting to this 5-year EBITDA target, but it seems like you could actually be destroying value for Dabir by protecting your consolidated EBITDA. If you are holding back on growth investment that this company might otherwise enjoy as a standalone, I guess, when you look at these kind of fast growing medical device companies, they are being valued on revenue and revenue growth. How do you think about that conflict or navigating that conflict as you deem the best course of action is to ramp investment to the detriment of your consolidated EBITDA?

That is an excellent question. Let me answer it with two statements. One, it’s only been of late – and I did start my career in healthcare, so I know the spending that goes on. It’s only been – and I would say the last 6 months that – and you may think of Methode corporate as you see in a way and that we invested into Dabir. That we have said maybe we do need to increase our spend there for a longer term gain. We are I think all companies, obviously, look at their P&L and their EPS. So, I don’t think we have hurt Dabir’s prospects by not maybe investing $15 million last year. I think that has gone well. Going forward and we have talked about it in my prepared remarks, now going forward, we will take a look at what – and we have asked the team, okay, what is needed to do more education? What do we have to do to get this on a faster pace? And they have been charged with that. And John – and when John and I were talking before you came on board and we did look for a CFO with a medical background, because we will look at how much should we spend. Now, is that another $2 million? That’s an easy decision. Is it another $15 million? I don’t have the answer to that, but I will tell you, we will, as a management team, invest what is necessary to make sure that we do not hamper their growth. Now, you realize I am going to get a call from the Dabir people after this call, but – and we will discuss that with the board, because it is at the point where as quasi BC here that we may need to make an additional investment in it. So, that’s not lost on us.

Okay, appreciate that thoughtfulness. And then just lastly, I just wanted to get your take on the Harman Samsung deal. You are just beginning this Tier 2 relationship with Harman, do you see any implications there either in terms of risk that they might in-house more or opportunity for you to potentially broaden that relationship inside of Samsung, maybe even outside of automotive?

Yes, we have lengthy discussion on that when that was announced. That was kind of out there that, that might happen. Our view is that it actually could be helpful to us and it was always a chance that somebody that large also sees when we do these things ourselves, but I don’t see them going in that direction. It’s more – I see them going more in the technology and that will be helpful to us. We positioned ourselves – and I have said this many, many times. We are the hardware supplier. And I just don’t see them deciding that they are going to get into that business. It’s always that possibility, but I’d say as a neutral to a benefit.

Okay, fair enough. Thanks very much for the color.

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

Alright. Thank you, Melissa. We will conclude and wish everybody a safe and pleasant holiday season. Thank you.