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Edited Transcript of MEI earnings conference call or presentation 6-Dec-18 4:00pm GMT

Q2 2019 Methode Electronics Inc Earnings Call

Chicago Jan 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Methode Electronics Inc earnings conference call or presentation Thursday, December 6, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Donald W. Duda

Methode Electronics, Inc. - President, CEO & Director

* Ronald L.G. Tsoumas

Methode Electronics, Inc. - VP of Corporate Finance & CFO

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Conference Call Participants

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* Christopher Ralph Van Horn

B. Riley FBR, Inc., Research Division - Analyst

* David Jon Leiker

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Ryan Ronald Sigdahl

Craig-Hallum Capital Group LLC, Research Division - Associate Analyst

* Steven Lee Dyer

Craig-Hallum Capital Group LLC, Research Division - Managing Partner & Senior Research Analyst

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Presentation

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Operator [1]

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Welcome to the Methode Electronics Fiscal Year 2019 Second Quarter Earnings Conference Call. (Operator Instructions) For this quarterly conference call the company has prepared a power point 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 2 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; fluctuation 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 cost 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.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [2]

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Thank you, Michelle, and good morning, everyone. Thank you for joining us today for our Fiscal 2019 Second Quarter Financial Results Conference Call. I'm 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'll 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 will drive higher margins.

As we mentioned in our release, Grakon's Automotive business has been included in the Automotive segment, while Grakon's nonautomotive business is in the industrial segment.

The busbar 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 have been working with Grakon for about 2 months, and see 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 that our businesses can work together. For example, bringing Methode sensor technology and displays along with Pacific Insight's ambient lighting technology to Grakon's customers. The teams came away with strong belief that our companies fit well together, especially given our culture is focused on delivering high-quality products, engineered solutions, growth through innovation and best-in-class manufacturing capabilities.

Next, we'll be referring to Slide 5 and 6 for a review of Methode's second quarter and first half sales. We closed on the acquisition of Grakon on September 12, so only 6 weeks of results are included. While overall sales improved year-over-year in both the second quarter and first half, organically our sales decreased in part due to the adoption of a new accounting standard regarding revenue recognition, which affected the accounting of tooling sales in our European operations.

Additionally, through the first 6 months, we were impacted by the $14 million annual price reduction on purchase displays, negotiated by a customer in the Automotive segment, we have discussed on previous calls.

Additionally, sales improvements in the Automotive segment driven by acquisitions and increased center console volumes were partially offset in both periods by several factors, impacting our European Automotive business: the implementation of the new European emission testing standards or the Worldwide Harmonised Light Vehicle Test Procedures; lower market demand for diesels, which has reduced car sales; and the continued shift in preference towards SUVs or passenger cars. Additionally, customer pricing reductions decreased sales in both periods.

As we announced in our release this morning, and as Ron will discuss further in his commentary, the aforementioned headwinds have impacted our guidance ranges for fiscal 2019. However, our strong cash flow generation has allowed us to invest in technologies, businesses and end markets such as Dabir, magneto-elastic sensing, LED lighting and now Grakon, which provide Methode the ability to continue to grow and increase long-term value despite these Automotive headwinds.

Industrial sales improved in both periods due to the addition of Grakon, but also due to increased Hetronic and Power Products sales. Interface sales were down significantly, due mainly to an issue with a directed supplier on a laundry program impacting our customer's launch. Our team is working aggressively with the customer and supplier to correct the issue.

Now please turn to Slide 7. GAAP earnings per share decreased from $0.64 to $0.39 in the second quarter, and from $1.19 to $1.02 in the first half. However, excluding acquisition-related expense and stock amortization expense, non-GAAP adjusted earnings per share were $0.75 in this second quarter compared to $0.74 last year, and $1.36 in the first 6 months compared to $1.34 in the same period last year. The year-over-year comparison in both periods, even on an adjusted basis, is essentially flat, primarily as a result of lower organic sales.

Next, we will be reviewing Slides 8 and 9. Adjusted earnings per share exclude acquisition-related expenses, including purchase accounting adjustments for inventory and severance and stock amortization expense due to the revised fiscal 2020 EBITDA estimate of the long-term incentive plan moving from threshold to target.

It is important to note that the maximum performance level of the long-term incentive plan allows management to achieve, through acquisitions, its target for $220 million in EBITDA in 2020. Therefore, the compensation expense recorded in the second quarter reflects this revision from threshold to target. That does not mean, however, that Methode cannot reach a higher EBITDA level in 2020.

Please move to Slide 10 for a review of gross margins. On a GAAP basis, consolidated gross margins were virtually unchanged year-over-year in the second quarter and decreased 40 basis points in the first half. However, excluding purchase accounting adjustments related to inventory and severance, non-GAAP adjusted gross margins improved 60 basis points in the second quarter and remain unchanged in the first half.

In both periods, gross margins were negatively impacted by an unfavorable sales mix and customer price reductions in the Automotive segment as well as significantly reduced sales in the Interface segment, partially offset by a favorable sales mix in the industrial segment and a favorable currency impact.

Please turn to Slide 11. In the Automotive segment, gross margins decreased in both periods, impacted mainly by increased Pacific Insight sales, which currently carry lower overall gross margins as well as by customer price reductions.

In the industrial segment, gross margins improved considerably in both periods with the addition of Grakon and improvements at Hetronic, partially offset by purchase accounting adjustments attributable to the Grakon inventory.

In the Interface segment, gross margins decreased in both periods due to significantly lower sales as well as a directed supplier issue I mentioned earlier.

Moving to new business awards and an update on Dabir. In total, new business representing $19 million in organic growth beginning in fiscal 2020 -- 2021, was awarded in the second quarter. A few highlights. European Automotive was awarded the BMW Integrated Tailgate Module, which includes an innovative camera wash feature developed by Methode. Average annual revenue for this 10-year program is $2 million, with a potential to expand to other platforms. Additional lead-frame business was also awarded from Continental with average annual revenue of $2.5 million over 6 years.

Our Power group was awarded a program for a battery disconnect unit for an EV with Byton. The battery disconnect unit is an electronic module, which contains the high voltage battery control, protection and measurement components, and is essentially the on-off controller for the battery pack. Average annual revenue is $5 million over 5 years.

Finally, Asian Automotive received a new award for a linear position sensor. The 6-year program with $4 million in average annual revenue, utilizes our magneto-elastic sensor.

As you can see on Slide 12, booked business utilizing our highly-patented Magneto-elastic technology, which has been deployed to create solutions for the automobile, e-bikes and commercial vehicle markets, will grow organically from $44 million last fiscal year to $74 million in fiscal year 2022 with the potential to increase further. I believe it's important to point out that this business is high-margin organic growth, which we seeded several years ago.

Now let's move on with an update on Dabir. During the second quarter, we added 2 new customers, Parkview Hospital in Indiana and Children's Medical Center in Dallas. All in all, we are seeing more revenue opportunities per quarter and experiencing a shorter lead time to revenue.

On the evaluation front, 11 clinical evaluations were started, managed or completed across the United States. Additionally, Dabir's largest evaluation to-date took place at Jackson Memorial in Florida, with 44 systems being used in the OR and ICU.

In the study, pressure injury incident rate was reduced to 0. We also conducted our first clinical evaluation in the Emergency Department at the Veterans Administration in Sacramento.

Finally, on the study front, Dabir's first post-acute, long-term care study completed last month was a reported pressure injury reduction from 18% to 0 on high-risk ventilator patients.

At this point, I'll turn the call over to Ron, who will provide more details on financial results and review guidance. Ron?

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [3]

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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 million -- $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, an 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.

An increase in 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 for severance. SG&A as a percentage of sales in the fiscal 2019 second quarter was 12.9% compared to 12.1% in the prior year and 13.3% in the fiscal 2019 first 6 months compared to 12.7% in the same period last year.

A few other financial items to review on Slide 15. Year-over-year, intangible asset amortization expense in the second quarter of 2019 increased $2.6 million to $3.7 million due to the amortization expense related to the Pacific Insight and Grakon acquisitions. This increased $3.9 million to $5.6 million in the 6 months period due to Pacific Insight, Procoplast and Grakon acquisitions.

The effective tax rate for the 6-month period was 16.4%. This was primarily due to lower pretax income and higher investment tax credits. The final impacts of tax reform may differ from the amounts we have estimated due to among other things, changes in the interpretation of tax reform and legislative guidance. The company currently anticipates finalizing and recording any adjustments within the 1-year allotted remeasurement period, which will occur in our third quarter of fiscal '19.

We anticipate that our effective tax rate will normalize for the fiscal year 2019, and estimate the full year effective tax rate to be in the range of 16% to 18%. In the first 6 months of fiscal 2019, we invested $28.6 million in capital expenditures, mainly just by programs and launches in North America and in Europe.

We continue to estimate our capital investment for 2019 to be into the $52 million to $58 million range. Expense for depreciation and amortization for this first 6 months was $18.4 million. For the full fiscal year 2019, we expect depreciation and amortization to be between $42 million and $46 million.

Shifting to the EBITDA Slide 16. The company generated $29.2 million in the second quarter or 11.1% of sales. For the 6-month period, EBITDA was $66 million or 13.5% of sales. For fiscal 2019, we expect EBITDA to be between $143 million and $157 million, are in the 14.3% to 15.1% sales range. Free cash flow in the second quarter was $28.1 million. We expect fiscal 2019 free cash flow to be between $63 million and $75 million.

I'll finish up my remarks with guidance beginning on Slide 17. As a reminder, the guidance ranges for fiscal '19 are based upon management's expectation regarding a variety of factors and involve a number of risks and uncertainties, which have been detailed in this morning's release in Form 10-Q.

As Don mentioned briefly, headwinds in the Automotive industry have significantly affected our business. Specifically, while our North American Automotive business has been stable due to our center console program, reduced passenger car sales has negatively impacted the revenues at Pacific Insight, and our lead-frame business is also expected to decrease 25% this year as compared to last year.

Lower passenger car production has also impacted our European and Asian Automotive revenues. Coupled with the new European emission standard, we are seeing lower European Automotive volumes with 4 of our key customers through year-end.

Please turn to Slide 18. As we detailed in our release this morning, there are also several items which are negatively impacting our income. The acquisition-related items we have already discussed, initiatives to reduce overall costs and improve operational profitability, which we announced previously but have increased by 600,000 and the potential impact of tariff. An international grant partially offsets these negative impacts.

Regarding tariffs, as a Chinese manufacturer, Grakon's products are included in list 3 of the section 301 import tariffs. The current tariff rate on these products is 10% of the import value, potentially rising to 25% on April 1, 2019. All of Grakon's customers have been informed that it is Grakon's intention to pass these new government mandated costs on. As expected, the procurement department of most customers have initially refused to accept these changes. Methode is working on mitigation plans to reduce and/or eliminate the impact of these tariffs to our customers.

Please turn to Slide 19. As we announced this morning, we have updated guidance to sales in the range of $1 billion to $1.04 billion, pretax income in the range of $91.5 million to $105.5 million and earnings per share in the range of $2.02 to $2.33.

In summary, the guidance -- updated guidance considers the negative impact of lower consolidated revenue and its contribution to income as well as the initiatives to reduce overall costs and improve future operational profitability. The impacts of acquisition-related expense of -- and tariffs partially offset by the benefits of 7.5 months of Grakon revenue and income and the international grant.

It is important to note that Grakon's pretax income carries significant intangible asset amortization, which is a noncash item. However, Grakon is a strong EBITDA and cash flow generating business.

Don, that concludes my comments.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [4]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Christopher Van Horn with B. Riley FBR.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [2]

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So if we could just get into the guidance for a minute. The $7 million -- $7.3 million that you've identified -- or that you're 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?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [3]

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The initiatives, for the most part, affect probably the latter half of our fourth quarter and [ripped] probably more of 2020, but they are geared to really adjusting our manufacturing levels to compensate for reduced sales, and I'll give an example because we have already implemented it.

At our Nelson British Columbia manufacturing site for Pacific Insight, we transferred the majority of Automotive manufacturing to our plants 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 a 2020 event.

And we are taking similar actions really around the world, which I really shouldn't go into in any great detail because some of those have not been announced. But that's us adjusting our factories and business for the reduced revenue. And also on to improve Pacific Insight's margin. So they are lower than Methode's standard margins, and part of our integration plan with (technical difficulty) on par with Methode's numbers.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [4]

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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?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [5]

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Absolutely, we have. Methode is fortunate that we have manufacturing sites around the world, and we've talked about in the past that we have light manufacturing in most of our plants. And Grakon's plant in China, most of the processes 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 help. 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, 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 are not -- like any customer they don't want to take the costs on. But the -- we've worked in those situations before. But we did provide in guidance for some effect of tariffs. But we can, long term, mitigate it.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [6]

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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?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [7]

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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 cars. So as Ron mentioned, that business was -- 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 necessarily want to name them, are all passenger car customers, so that's effective. So the biggest effect is Europe, the second, by lead-frame and then third by just our Chinese production being off as well. But the lion's share of it is Europe and lead-frame.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [8]

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Okay. And then last one for me. Now that Grakon is closed, can you help us -- give us some timing? I mean, I imagine there's a number of revenue synergies when you look at that customer list that they 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's closed and what opportunities you have?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [9]

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The biggest opportunity is -- 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 an 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 will be very helpful. Our center consoles and our touch screen 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 cabs where we can replace it with the 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 of -- as if the tariffs weren't an issue, we're looking at Grakon's manufacturing, which is not bad. It's just not up to Methode's standards. But there is quite a bit of savings we anticipate from the Grakon factory now working under our Chinese Methode operation.

And then also as we always do, we're looking at procurement. We buy a lot LEDs, they buy a lot of LEDs. This is going to be cost-savings there. We're also looking at resins and copper and the usual items, and we did the same with Pacific Insight. Ron is there anything?

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [10]

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

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Operator [11]

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Our next question comes from the line of David Leiker with Baird.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [12]

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Couple of things. I'll 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's a pretty meaningful acceleration in revenue growth here going forward. And what do you think that longer-term outlook looks like?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [13]

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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 growth but steady order flow.

So what you saw in our filings last week was -- well, over the last 12 months. And that's really a 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 are up, and we are going by customer forecasts.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [14]

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Is there -- have you looked at it? Or do you have the ability to give us some characterization of your revenue growth in -- at Grakon? How that's performing relative to what the end market is doing?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [15]

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We can't give you great detail, but do know that they are outperforming the -- slightly outperforming the market. And they've been -- and some of it -- is they've expanded into other areas, so some of their industrial lighting.

And I would lump Tesla into that, they've gotten growth from Tesla, but again -- now we put that into our Automotive. So they are probably on par with Class 8 trucks, and I think from their other -- in fact we know from their other initiatives, they are ahead.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [16]

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Great. And then some of these actions you've taken particularly on the Automotive side of the business, there was -- some of the volatility, uncertainty there. I know you talked about some of those. I guess I want to addresses this in the context of the weaker volumes not necessarily the tariffs side of that equation. How many -- how much of that do you think are blocking and tackling kind of changes versus structural work that you need to do?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [17]

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I don't think we have to do wholesale restructuring, we've been through that. But we'll be adjusting our manufacturing spend to the reduced revenue rate to maintain our margins. And I point it 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 whole lot to talk about that. But they are the usual items that a automotive supplier would take.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18]

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And then, 2 last things here, I -- just on Automotive one more thing. We went through Q3 earnings -- calendar Q3 earnings with a lot of suppliers pulling in numbers. WLT being a part of that, China being part of that, passenger cars being a part of that. And it seems most are, if not all of that is impacting you. Is there anything beyond that that you're seeing that's not covered by those kind of macro issues that we're dealing with?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [19]

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No, we exclude tariffs. I think Ron detailed that fairly well. If this was 8 weeks ago we wouldn't have changed our outlook for Automotive. What we saw really in the last 6 weeks was a dramatic downturn in Europe and the releases that we get. And while we're very pleased that we're on truck and SUV here in America, it's not enough to offset those other reductions. But...

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [20]

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Yes, those -- go ahead.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [21]

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

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [22]

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But the build rates in Europe seem to be coming back. For most of the manufacturers, they're still some who are lagging a little bit. I presume you're starting to see some of that though.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [23]

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We have seen it, but we haven't seen it in releases and in our forecasting models. So that -- I'm hesitant because Europe has always been a 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.

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24]

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Okay. And then the last item, in '16 where you have the EBITDA number, and you put an estimate out there for EBITDA in fiscal '19, and then you talk about your threshold that you're fit for 2020. And if you do the math on this, 40% to 50% increase in EBITDA. Is that the right way to be looking at that?

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [25]

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Yes, I -- with our LTIP plans, we booked the adjustment to the plan called for 220 (technical difficulty) targets. That's our anticipated -- $220 million is our anticipated EBITDA for fiscal year 2020. It includes all onetime events as well that are going to occur, and the rest of the performance of our business units year-over-year from fiscal '19 to fiscal '20, sitting here as we [state].

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David Jon Leiker, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [26]

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

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [27]

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We are at an incentive comp accrual rate that gets us to target, which is -- at least to target, which is $221 million.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [28]

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

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [29]

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Right.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [30]

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The plan tops off at that $221 million. And again, it's based on an accounting requirement that Ron and I be at least 75% confident.

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [31]

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So David, a good way of looking at it may be is to say our fiscal 2020 numbers that have been contemplated in the estimate already include 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.

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Operator [32]

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Our next question comes from the line of Steve Dyer with Craig-Hallum.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [33]

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Ryan Sigdahl on for Steve Dyer. 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?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [34]

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Yes, on GAAP.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [35]

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

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [36]

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Yes.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [37]

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Fiscal '19, one-timers, correct.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [38]

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Okay. And then as it relates to Grakon. How long do you think it'll take to turn its inventory and get back to normalized gross margins there?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [39]

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Normalized, I'm not -- 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 their inventory down. But the...

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [40]

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Are you referring to the step up in -- from the -- in inventory value from the purchase accounting that's running through in this current fiscal year?

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Steven Lee Dyer, Craig-Hallum Capital Group LLC, Research Division - Managing Partner & Senior Research Analyst [41]

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Yes, that is what I was referring...

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [42]

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Yes, so we had -- 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'll be done. So any impact of the purchase according to inventory will be done in the third quarter.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [43]

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All right. And then maybe another clarification. What segment will PowerRail 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?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [44]

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It'll be in industrial or is now in industrial. And as far as the -- customer orders have 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'll see 6 to 12 months or below. But we are not seeing that at the moment.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [45]

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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?

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [46]

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That was the expected. That's no different than an Automotive customer on a -- copper price increases. It's always a negotiation and let's call it a polite heated discussion. And we will work -- we work through that -- if we were talking with the Detroit customers. It's always the -- no, we're not paying for that, no, we're not paying for it, and sooner or later you get to a compromise. So that -- I would call that normal course of business, and we're dealing with it.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [47]

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And we -- and again, I want to stress, we have alternatives. 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's going to pay for it, but we can at least show them a plan, here's how we can mitigate this. So that's a big advantage to Grakon and the Grakon customers.

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Operator [48]

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

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [49]

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

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Operator [50]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.