Welcome to the Methode Electronics Fiscal Year 2019 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. For this quarterly conference call, the company has prepared a PowerPoint Presentation entitled fiscal 2019 second quarter earnings which can be found at methode.com in the Investor Relations section. [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, commercial vehicle, computer and communications industries, international trade disputes resulting in tariffs, investment in programs prior to the recognition of revenue, timing quality and cost of new program launches, changes in U.S. trade policy, ability to withstand price pressure, including pricing reductions, ability to successfully market and sell Dabir Surfaces, currency fluctuations, customary risks related to conducting global operations, recognition of goodwill impairment charges, dependence on the availability and price of raw materials, fluctuations in our gross margins, ability to withstand business interruptions, successfully benefit from acquisitions and divestitures, dependence on our supply chain, income tax rate fluctuations, ability to keep pace with rapid technological changes, breach of our information technology systems, ability to avoid design or manufacturing defects, ability to compete effectively, ability to protect our intellectual property, success of Pacific Insight and Procoplast and/or our ability to implement and profit from new applications of the acquired technology, significant adjustments to expense based on the probability of meeting certain performance levels in our long-term incentive plan and costs and expenses due to regulations regarding conflict minerals. Additionally, this conference call will present both GAAP and non-GAAP financial measures. A reconciliation of these measures is included in today’s earnings release which you can find on our Investor Relations website. I would now like to turn the call over to Don Duda, President and CEO. Please go ahead, sir.

Thank you, Michelle and good morning everyone. Thank you for joining us today for our fiscal 2019 second quarter financial results conference call. I am joined today by Ron Tsoumas, our Chief Financial Officer. Both Ron and I have comments and afterwards, we will take your questions. In our presentation and commentary this morning, we will discuss our new segments, highlight second quarter and first half results, discuss tariffs and review updated guidance. To start, I will ask you to turn to Slide 4. With the addition of Grakon, we have reorganized Methode’s reporting segments to reflect the evolution we have been discussing for the past few years. With this new structure, Methode becomes a one stop shop for electronically controlled LED lighting solutions, integrated user interfaces and sensors. Additionally, the complementary products, technology and manufacturing capabilities across all Methode segments will foster additional innovation and unique custom solutions which would drive higher margins. As we mentioned in our release, Grakon’s automotive business has been included in the automotive segment, while Grakon’s non-automotive business is in the industrial segment. The best of our business previously in Power Products is now part of the industrial segment and the Power Products segment has been eliminated. Hetronic, previously included in Interface is now part of the Industrial segment. And Dabir previously included in the other segment now makes up the Medical segment. The other segment has been eliminated. A brief update on Grakon. We’ve been working with Grakon for about 2 months and seen a number of synergies both from a product and from a manufacturing standpoint. To that end, we just finished a week-long meeting with key sales and engineering teams across all of Methode, including Automotive, Pacific Insight, Hetronic, Sensors and Grakon. I was very pleased with the number of areas…

Thank you, Don and good morning everyone. Please turn to Slide 13. As Don mentioned GAAP net income for the fiscal 2019 second quarter was $14.6 million compared to $24.2 million in the same period last year. Second quarter GAAP net income was negatively impacted by increased acquisition related costs of $3.5 million and increased purchase accounting adjustments of $3.2 million totaling $6.7 million. Higher stock award amortization expense due to the revised fiscal 2020 EBITDA estimate for the long-term incentive program of $5.7 million and higher interest expense of $1.8 million. And increased intangible asset amortization expense related to the Pacific Insight and Grakon acquisitions of $2.6 million. These impacts were partially offset by decreased income tax expense of $1.9 million and lower legal fees of $1.1 million. For the 6 months, GAAP net income was negatively affected by increased acquisition related costs of $1.5 million and increased purchase accounting adjustments of $3.2 million totaling $4.7 million, increased intangible asset amortization expense related to the Pacific Insight, Procoplast and Grakon acquisitions of $3.9 million, higher stock award amortization expense due to the revised fiscal 2020 EBITDA estimate of the long-term incentive program of $3.7 million, higher interest expense of $1.8 million and higher overall compensation expense of $1.5 million. These impacts were partially offset by lower legal fees of $2.8 million and lower income tax expense of $1.7 million. Turning our attention to SG&A on Slide 14, in the second quarter, GAAP SG&A as a percentage of sales, was 18.2% compared to 13.6% in the prior year and 15.9% in the fiscal 2019 first 6 months compared to 14.1% in the same period last year. However, on a non-GAAP adjusted basis, which excludes acquisition-related expenses, stock award amortization expense true-up for the long-term incentive program and purchase accounting adjustments…

Thank you, Ron. Michelle, we are ready to take questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Christopher Van Horn with B. Riley FBR. Please proceed with your question.

Good morning. Thanks for taking my call.

Good morning Chris.

So, if we could just get into the guidance for a minute the $7 million – $7.3 million that you have identified or that you did that are going to be using to reduce cost and improve profitability, how does that translate into margin – potential margin opportunity, what does that look, can you quantify that a little bit and then what exactly are some of these initiatives?

The initiatives for the most part affect probably the latter half of our fourth quarter and probably more 2020. But they are geared to really adjusting our manufacturing levels to compensate for reduced sales. And I will you an example because we have already implemented that at our Nelson, British Columbia manufacturing site for Pacific Insight. We have transferred the majority of automotive manufacturing to our plants there in Mexico. That has taken effect, but there is severance included in that and that will benefit us later on in the year, but not in – certainly not in the second quarter and a little bit in the third quarter, but mainly fourth quarter and the 2020 event. And we are taking similar actions really around the world, which we really shouldn’t go into any great detail, because some of those have not been announced. But that’s adjusting our factories and business for the reduced revenue and also to improve Pacific Insight’s margins. They are lower than Methode’s standard margins and part of our integration plan is on par with Methode’s numbers.

Okay. Got it. And then looking at China, looking at the tariffs, have you looked at alternative sourcing or shifting capacity and what’s the timing of that if you have?

Absolutely, we have. Methode is fortunate that we have manufacturing sites around the world and we’ve talked about on the past that we have light manufacturing in most of our plants and Grakon’s plants in China, most of the process they have there, we have elsewhere. So we are working actually quite hard to move some of that manufacturing as appropriate to other locations that will not be impacted by the tariffs. And again, Methode has – we have operations in Mexico, in Malta, in Egypt. So we have the ability to for the most part mitigate the tariffs, it’s not something that you can do overnight, but we are working to do that. And our view is, the 10% tariff we have to plan on, and 25%, we’ll see what happens there, but the 10% we think is likely to stay for a while and we’re making necessary adjustments and working with our customers. And as Ron mentioned they’re not like any customer they don’t want to take the costs on, but we’ve worked in those situations before, but we didn’t provide any guidance for some effect of tariffs, but we can long-term mitigate it.

Okay. Got it. And then have you quantified or could you quantify your passenger car exposure specifically in North America and then if you can in other regions?

Sure. Our entire lead-frame business goes into transmissions for passenger cars. The biggest piece of business we have with Continental is for the T76, 6-speed transmission for GM, which goes into the passenger car. So as Ron mentioned that business has been significantly affected, which affects our U.S. revenue, as well as our Chinese revenue. And then in Europe, our top 4 customers, I don’t unnecessarily want to name them, are all passenger car customers, so that’s affected. So the biggest effect is Europe; the second by lead-frame; and then third, by just Chinese production being off as well. But the lion’s share of it is Europe and lead-frame.

Okay. And then last one for me. Now that Grakon is closed, could you help us give some timing, I mean, you mentioned there’s a number of revenue synergies when you look at that customer list that, that would like to get access to the Methode product. Could you give us a timing or just an idea of how to think about the pipeline now that Grakon is closed and what opportunities you have.

The biggest opportunity is with short-term we see with moving some of the Grakon products into our Hetronic distribution system because of the various interior lighting they have for industrial applications, that’s a short-term synergy. It’s hard to quantify exactly what that would be at this point. Long-term and when I say long-term, this is getting into ‘21, ‘22, when we look at Class 8s and below bringing Pacific Insight’s Ambient Lighting into play. I think it will be very helpful. Our center council and our touchscreen capabilities we know that is attractive to Grakon’s customers, but again that will develop as they revamp the interiors of the cabs, that’s not something that we will see in next year. Lighting we may see next year, because that’s not a wholesale change to the vehicle and there is still quite a bit of incandescent lighting in the cab. So, we can replace it with LEDs, but it’s really too soon to really to point to any major revenue opportunity. What we see short-term with Grakon is bringing – and I will speak as if the tariffs weren’t an issue. We are looking at Grakon’s manufacturing, which is not bad. It’s just not up to Methode standards. There is quite a bit of savings we anticipate from Grakon factory now working under our Chinese Methode operation. And then also as we always do we are looking at procurement, we buy a lot of LEDs, they buy a lot of LEDs. This is going to be cost savings there. We are also looking at present in copper and then the usual items and we did the same with Pacific Insight. Ron, is there anything?

No, the procurement is the piece that we could gain traction on very quickly.

Okay, great. Thanks so much, guys. I will hop back in the queue.

Alright. Thanks, Chris.

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

Good morning, everyone.

Good morning David.

Couple of things. I stay on Grakon for a moment. Can you talk a bit about what the bookings have been like and contract awards, it looks like there is a pretty meaningful acceleration in revenue growth here going forward and what you think that longer term outlook looks like?

Okay. We just did a review of that. It remains very robust from the last several months. Now, I know that some Class 8 orders have decreased, but Class 5 and 6 are up the customers continue to project, I wouldn’t say, increased study, a study order fall. So what you saw in our filings last week was little over the last 12 months and that’s really result of the upturn in the Class 8 vehicles. And right now, we see maybe Class 8 down a little bit, but the other classes up and we are going by customer forecasts.

Is there – have you looked at it or do you have the ability to give us some characterization of your revenue growth at Grakon, how that’s performing relative to what the end market is doing?

We can’t give you great detail, but do know that they are outperforming the – slightly outperforming the market. And some of it is they have expanded into other areas, so some of their industrial lighting, I would love test into that, they have got to grow from test, but again now we put that into our automotive. So they are probably on par with Class 8 tracks and I think from their other – in fact we know from their other initiatives they are ahead.

Yes. And then some of these actions you are taking particularly on the automotive side of the business, it’s some of the volatility uncertainty there. And I know you talked about some of this, so I want to address this in the context of the weaker volumes, not necessarily the tariff side of that equation, how much of that do you think are blocking and tackling kind of changes versus structural work that you need to do?

Well, I don’t think we have to do wholesale restructuring. So we went through that. But we will be adjusting our manufacturing spend to the reduced revenue rate to maintain our margins. And I mean I pointed to the action we took in Nelson and there’s similar actions that we would take around the world, but it’s difficult David without having announced a lot to talk about that, but they are the usual items that a Automotive supplier would take.

And then a few last things here just on Automotive one more thing. We went to Q3 earnings, calendar Q3 earnings with a lot of suppliers pulling in numbers, WLTP being a part of that, China being part of that, passenger cars being a part of that. It seems most are, if not all of that is impacting you. Is there anything beyond that, that you are seeing that’s not covered by those kind of macro issues that we are dealing with?

If we exclude tariffs, I think Ron detailed that fairly well.

Okay.

This was 8 weeks ago and we wouldn’t have changed our outlook for Automotive when we saw really in the last 6-week was a dramatic downturn in European – in Europe and the releases that we get. And while we’re very pleased that we are on truck and SUV here in America, it’s not enough to offset those other reductions. But –

But the build rates – go ahead.

No, there are no other items that we haven’t talked about. I think Ron detailed it very well.

But the build rates in Europe seem to be coming back, for most of the manufacturers they’re still somewhere liking a little bit, I would presume you’re starting to see some of that though?

We have seen it, but we haven’t seen it in releases and in our forecasting models. I’m hesitant because Europe has always been little volatile. I’m hesitant to say we may see a better second half than we anticipate, because we really haven’t seen it in our customers’ orders.

Okay. And then the last item, in ‘16 [ph] we have the EBITDA number and you put a estimate out there for EBITDA in fiscal ‘19 and then you talk about your threshold that for 2020, and if you do the math on that, it’s a 40% or 50% increase in EBITDA. Is that the right way to be looking at that?

Yes. I – with our LTIP Plan, we book the adjustment to the plan call for $221 million target, that’s our anticipate – at least $221 million is our anticipated EBITDA for fiscal year 2020. And it includes all one-time events as well that ongoing to occur [ph] and the performance of business units year-over-year from fiscal ‘19 to fiscal ‘20 sitting here as we state now.

And where you are on the incentive comp accrual, is that at a level that assumes you get to that number?

We are at – incentive comp accrual rate that gives us to target, which is $200 million – at least to target, which is $221 million.

Okay.

In my prepared remarks, Methode can achieve higher than that.

Right.

Right.

The plan tops of it at $221 million.

And again, it’s based on an accounting requirement that Ron and I’d be at least 75% confident.

So David a good way of looking at it maybe as to say our fiscal 2020 numbers that have been contemplated in the estimate, already 2020 amortization up to target and the impact of 2020 on that increase already. So all of that is contemplated in the fiscal 2020 number.

Okay. That’s why I thought, I just wanted to make sure I understand it correctly. Thank you very much.

Thank you, David.

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

Hi, guys. Ryan Sigdahl on for Steve Dyer.

Hi, Ryan.

Maybe one clarification on that last question there. Is the EPS and EBITDA guidance that you guys provided on an adjusted basis or is that on a GAAP basis?

GAAP.

So presumably that 50% EBITDA growth that was just mentioned is lot of that is adjustments in this year that won’t reoccur next year, correct?

Yes.

Fiscal ‘19 one-timer is correct.

Okay, thank you. And then as it relates to Grakon how long do you think it will take to turn its inventory and get back to normalize gross margins there?

Well, I can answer the question on inventory. They have too much inventory and with Methode’s manufacturing systems and our ability to lean out factories we will get your inventory down, but…

You are referring to the step up and from an inventory value from the purchase accounting that’s running through this current fiscal year.

Yes, that is sort of three?

I believe we had $2.6 million of step up this quarter and we anticipate maybe another $3 million in the second quarter thereabouts and then that will be done. So, any impact of the purchase to accounting inventory will be done in the third quarter.

Alright, thank you. And then maybe another clarification, what segment will power rail and its big data customer be in and then what are you hearing from that customer in terms of expansion plans and what they are thinking?

It will be in industrial. And as far as the customer orders had stayed I would say robust and we have not and this has happened in the past where they will complete their capacity increase and then we will see 6 to 12 months of the low, but we are not seeing that at the moment.

Okay, last one for me. I think if I caught it right in your prepared remarks, you mentioned that Grakon customers have not been willing to accept pass-through of tariff costs, can you elaborate on those negotiations…

That will be affected and it is no different than our automotive customer on copper price increases. It’s always a negotiation let’s call it a polite heated discussion. And we work through that. If we were talking with the Detroit customers, it’s always no we are not paying for that, we are not paying for it we will sooner or later get to a compromise. So that’s I will call out normal course of business. And we are dealing with it. And again I want to stress we have alternatives, right, where if you take Grakon before Methode acquisition, they didn’t have an alternative, they would have to really dig in with their customers. We have the ability at least to go to customers and yes, we argue over who is going to pay for it, but we can at least show them a plan, hey, here is how we can mitigate this. So, that’s a big advantage to Grakon and the Grakon customers.

Good. I will leave it there. Thanks, guys and good luck.

Thank you.

Thank you. There are no further questions at this time. I would like to turn the call back over to Mr. Duda for any closing remarks.

Thank you, Michele. We will wish everyone a very safe and pleasant holiday season and thank you for calling in. Take care.