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Edited Transcript of MEI earnings conference call or presentation 29-Aug-19 3:00pm GMT

Q1 2020 Methode Electronics Inc Earnings Call

Chicago Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Methode Electronics Inc earnings conference call or presentation Thursday, August 29, 2019 at 3:00:00pm 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

* Ryan Ronald Sigdahl

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

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Methode Electronics Fiscal Year 2020 First Quarter Conference Call. For this quarterly conference call, the company has prepared a PowerPoint presentation, entitled Fiscal 2020 First Quarter Earnings, which can be found on methode.com in the Investor Relations section.

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 speaks only as to the date hereof. These forward-looking statements are subject to a safe harbor protection provided under the securities law.

Methode undertakes no duty to update any forward-looking statements to conform these statements to actual results or changes in Methode's expectations on a quarterly basis or otherwise.

Forward-looking statements in this conference call include 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: Number one, dependence on a small number of large customers, including 2 large automotive customers; two, dependence on the automotive appliance, commercial vehicle, computer and communications industries; three, international trade disputes resulting in tariffs and our ability to mitigate tariff; four, timing, quality and cost of new program launches; five, the ability to withstand price pressure, including pricing reductions; six, ability to successfully market and sell Dabir Surfaces products; seven, currency fluctuations; number eight, customary risks related to conducting global operations; nine, the ability to withstand business interruptions; 10, recognition of goodwill impairment charges; 11, ability to successfully benefit from acquisitions and divestitures; 12, investment in programs prior to the recognition of revenue; 13, dependence on the availability of price and materials; 14, the fluctuations in our gross margins; 15, dependence on our supply chain; 16, income tax rate fluctuations; 17, ability to keep pace with rapid technological changes; 18, breach of our information technology systems; 19, ability to avoid design or manufacturing defects; 20, ability to compete effectively; 21, ability to protect our intellectual property; 22, success of Grakon and/or our ability to implement and profit from new applications of the acquired technology; 23, significant adjustments to expense based on the probability of meeting certain performance levels in our long-term incentive plan; and 24, cost and expenses due to regulations regarding conflict materials.

(Operator Instructions) At this time, it is my pleasure to turn the floor over to your host for today, Mr. Don Duda. Sir, the floor is yours.

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

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Thank you, Jess, and good morning, everyone. Thank you for joining us today for our fiscal 2020 First 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.

To start, I will ask you to turn to Slide 4. Our strong first quarter results, which improved record sales as well as record EBITDA, were attributable to both sales growth and operational efficiencies. The automotive segment outperformed relative to the global automotive market, which continued to be weak -- to weaken during the quarter. Importantly, the segment's organic revenue decline slowed to just 1.4% year-over-year, the lowest level in 4 quarters, versus the global automotive volume decline of about 10%. Additionally, we saw the benefit of the initiatives we took last year to reduce costs and improve profitability as well as successful tariff recovery efforts. Ron will cover this more in his detailed remarks.

Also during the first quarter, new business wins and business development efforts in both automotive and industrial segments continued to capitalize on important trends, including safety and electrification. Finally, at Dabir, we continued to add new customers and made significant progress on lowering the average evaluation time.

Turning to Slide 5 for a few comments on our key financial metrics. Year-over-year, consolidated sales improved 21%, in line with our internal expectations. Additionally, GAAP net income improved 19%, while adjusted net income, which excludes expenses for initiatives to improve operations and acquisition-related expenses in the applicable period, improved 14%.

On Slide 6, you can see our automotive segment is successfully navigating some significant industry and macro headwinds. While our Asian operations affected by the decline in passenger car sales and the ongoing trade and tariff dynamics, the fact that our exposure to domestic Chinese OEMs is limited to 8% of sales has somewhat mitigated the impact of these macro factors. Additionally, we believe new products launching during fiscal 2020 should help us offset these headwinds. In fact, in Europe, the new launches have nearly offset the effect of the economic uncertainty and revised GDP forecast.

Grakon sales in Tesla as well as new launches and the strong mix of products for SUVs and pickup trucks have bolstered the North American operation. It is important to note that the new launches I just mentioned will continue to ramp throughout the next 3 quarters.

Please turn to Slide 7. Our boat business and sensors grew 11% year-over-year and is anticipated to grow from $56 million this year to over $94 million by fiscal 2022, further validating our strategy to move the company into higher-margin technology business. Our highly patented magnetoelastic technology also provides steering assist on sport and recreation vehicles and clutch plate position for automobiles as well as active roll control to improve safety.

Moving to Slide 8. Our portfolio of technologies and solutions for the hybrid and electric vehicle market and RGB LED-based ambient and direct lighting led to a solid quarter of new business awards totaling $30 million. European Automotive was awarded Jaguar Land Rover's common architecture program. Jaguar's strategy to create common modules and standardizing all future electric and hybrid vehicles within their portfolio utilizes our power-operated tailgate switch, steering panel shift as well as glove box and instrument panel switches. With the 5-year program life, annual revenue is $5 million launching in the second quarter of fiscal 2021.

Grakon was awarded additional content on Rivian's electric pickup and electric SUV models: the Rivian console lamp and the footwell and floor tray lamps, launching in the second quarter of fiscal 2021. With these new awards, total content per Rivian vehicle between Grakon and Pacific Insight is $188 for the pickup truck and $228 for the SUV. Grakon was also awarded the Tesla Model Y combination [coat hook] reading light with estimated annual revenue of $3 million, launching in the third quarter of fiscal 2020. With this award, total content per vehicle across all Methode businesses for the Tesla Model Y is

$160. Notably, for the Tesla Model S and X, Methode's total content per vehicle has grown to $300.

Our automotive group in Asia was awarded [11 million]

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busbars on 2 current electric transmission programs, both beginning in the third quarter fiscal 2022. The busbars are for PSA's new DS3 crossback and Hyundai's Lafesta and Encino vehicles. Additionally, Nissan-Mitsubishi awarded a busbar program for an electric vehicle with average annual revenue of $11 million, launching in the second quarter of fiscal 2021.

Pacific Insight and Grakon's lighting technologies and capabilities, together with Methode's expertise in both power distribution solutions and automotive manufacturing, will provide opportunity for market share gains and increased content across Methode.

Moving to an update on Dabir. During the first quarter, we added 5 new customers, including our third pediatric hospital. Additionally, our evaluation time for systems at hospitals averaged 48 days in the first quarter, down from 77 days in the first quarter of last year. We also began the first evaluation using our Gen II system at a Midwest hospital network in the ICU. Our Gen II system was designed for patient care areas of the hospital, that is care areas outside the operating room. It has the same therapeutic characteristic as the Gen I system, yet is more compact and lightweight and provides the bedside clinician with more display information, such as remaining surface light. It also has an auto brightness feature so patients can sleep better at night.

In closing, our performance in the first quarter gives us confidence in our full year outlook and ability to execute in a very challenging macro environment.

At this point, I'll turn the call over to Ron, who will provide additional detail on our financial results and give you guidance.

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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, everybody. Please turn to Slide 9. First quarter sales improved 20.9%, or $46.8 million, to $270.2 million in fiscal '20 from $223.4 million in fiscal '19. Sales from Grakon and new automotive launches more than offset overall market weakness in Europe and China as well as lower radio remote control, appliance and data solution sales. Foreign currency exchange continued to be a headwind as the euro and renminbi exchange rates were weaker than the prior year.

Moving on to Slide 10. On a GAAP basis, first quarter net income increased $4.6 million to $28.3 million or $0.75 per share from $23.7 million or $0.63 per share in the same period last year. First quarter GAAP net income benefited from the results of Grakon and the net benefit we received from initiatives to reduce costs and improve profitability from last year, which included the absence of the expense for those actions we had.

Negatively impacting first quarter GAAP net income were lower radio remote control appliance and data solution sales, higher expenses for net interest, intangible amortization, income tax, stock-based compensation and net tariffs as well as the impact of foreign currency translation.

Our first quarter tax rate of 20.5% was impacted by discrete items recorded during the period. Excluding the impact of these discrete items, our first quarter tax rate would've been approximately 16.5%, which is comparable to the first quarter of last year. Our expected rate for the remainder of the fiscal year is expected to be lower than we experienced in the first quarter. Therefore, in spite of a higher-than-anticipated effective tax rate in the first quarter, we now estimate that our tax rate will be in the range of 18% to 20% in fiscal 2020, slightly lower than the 18% to 21% rate announced in June.

China tariffs continue to be a headwind although we're aggressively working to mitigate the impact on our results. In the first quarter, our net tariff expense of $0.3 million also included tariff revenue reimbursement offsets related to fiscal '19, which were agreed to during the first quarter by some of our customers. Therefore, the amount recognized in the first quarter does not represent a run rate for the remainder of the year.

We expect the net impact of tariffs to be higher for the remaining quarters of fiscal '20 but lower than the $8.5 million net expense we estimated during our Fiscal '19 Earnings Call. We also are closely monitoring the announcement from last week that tariffs could increase to 30% from 25%, beginning on October 1. Currently, we believe tariffs for the fiscal year will be in a range of $4.5 million to $5.5 million at the current 25% tariff rate.

Moving to margins on Slide 11. First quarter GAAP gross margins and non-GAAP adjusted gross margins improved 120 basis points year-over-year in fiscal '20.

Gross margins improved due to Grakon sales, partially offset by the negative impact of foreign currency translation and reduced Hetronic sales. Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce cost and improve profitability in the applicable period.

First quarter GAAP selling and administrative expenses as a percentage of sales decreased 120 basis points year-over-year, positively impacted by the absence of the expense for operational improvements and the benefit of those improvements, lower acquisition costs and foreign currency translations, and by selling and administrative initiative expense attributable to Grakon, which is lower as a percentage of sales than Methode as a whole.

Non-GAAP selling and administrative expenses as a percentage of sales, which exclude acquisition-related costs and expense for operational improvements, still improved 60 basis points year-over-year in the first quarter of fiscal '20.

Shifting to EBITDA on Slide 12. The company generated a record $50.3 million in the fiscal '20 first quarter, or 18.6% of sales, versus $36.8 million or 16.5% of sales in the same period last year. However, adjusting for expenses for initiatives to reduce overall cost and improve operational profitability and acquisition-related costs in the applicable period, first quarter 2019 adjusted EBITDA was $38.2 million or 17.1% of sales.

A few additional items to review. Year-over-year, intangible asset amortization expense in the fiscal '20 first quarter increased $2.9 million or 152.6% to $4.8 million, primarily due to the amortization expense related to the Grakon acquisition.

In fiscal '20 first quarter, we had invested approximately $13 million in CapEx, mainly to support programs and launches in North America and Europe. Expense for depreciation and amortization for the fiscal '20 first quarter was $11.8 million.

Let's move to Slide 13. Free cash flow for fiscal '20 first quarter was $26.9 million. Our debt-to-EBITDA ratio, which is used for our bank covenants, is approximately 1.6. We paid down nearly $11 million in debt during the quarter. And since purchasing Grakon, we've reduced our debt by $85 million. We ended the quarter with just over $73 million in cash.

Move to Slide 14. I'll finish off my remarks with guidance. As a reminder, the guidance ranges for fiscal '20 are based upon management's expectations regarding a variety of factors and involve a number of risks and uncertainties, which have been detailed in this morning's release in the Form 10-Q and our Form 10-K. As we announced this morning, we affirmed fiscal '20 sales in the range of $1.13 billion to $1.17 billion, pretax income in the range of $150.3 million to $164.3 million, and earnings per share in the range of $3.25 per share to $3.55 per share.

As discussed during our last earnings call, the majority of our new automotive and e-bike program launches will not be at full production volumes until the second half of the fiscal year. Additionally, the laundry care program is anticipated to launch in our fiscal third quarter.

While our estimated tariff expense is now potentially lower than originally anticipated, market choppiness related to a number of industry-wide and macro headwinds will continue to impact our fiscal year. These include the shift away from sedans and traditional passenger cars, the dollar strengthening against most major currencies and the anticipated softening in the commercial vehicles markets in the second half of our fiscal year. For fiscal '20, we are estimating capital investment to be in the $48 million to $54 million range and depreciation and amortization to be between $51 million and $54 million.

Lastly, we expect our fiscal '20 free cash flow to be between $122 million and $136 million.

In conclusion, please move to Slide 15 to look at the key drivers of our anticipated EBITDA performance for fiscal '20.

Looking at EBITDA based on our $155 million of EBITDA in fiscal '19, adding EBITDA from new automotive and laundry program launches of about $19 million; adding EBITDA from a full year of Grakon, which is about $21 million; subtracting the impact of the loss of EBITDA from reduced passenger car production, which we estimate to be around $14 million; adding the benefit of the initiatives to reduce cost and improve profitability of about $11 million; and adding back the onetime cost we incurred in fiscal 2019 for acquisitions and restructuring of about $29 million.

Don, that concludes my comments.

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

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Ron, thank you very much. And Jess, 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) We'll go first to Chris Van Horn of B. Riley FBR.

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

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Congrats on the quarter. I just wanted to dig a little bit deeper, if we could, on the award activity because it seems like you had a strong quarter in terms of awards across the board here. Any sort of drivers that stuck out to you, either from a competitive standpoint or just from a customer pickup perspective?

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

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Sure. We've said this in the past, Methode is somewhat unique in that we are a seasoned automotive manufacturer and we are in the busbar business. And so our awards (inaudible) but I think half probably were in electrification. Coming from that fact, we supplied Tesla for a number of years, we got a good track record there, so it's not necessarily surprising that we are getting other business. We've announced wins with Volkswagen, and then we've got Rivian and several others. So I think that makes us somewhat unique. And then some of the lighting wins, just Grakon doing a good job of booking business, and Methode as well. And some quarters are better than others. This was a good booking quarter. I think last quarter was a little lighter. But it was a nice quarter, $30 million of wins. Hitting $21 million and $22 million will definitely help us drive organic growth.

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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 maybe on that point, I remember when you made the Grakon acquisition, there was a lot of possibilities or opportunities, if you will, to get with your existing customers who you are supplying as well as kind of showcase some of the maybe traditional Methode capabilities to some of Grakon's customers. Have you seen that come to fruition?

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

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We've done -- I think we talked about it last quarter. We've done tech days for the many of the key customers. That has given us opportunities. We've got some nice opportunities that we're working on, but at this point, nothing major to announce. But we are -- we're seeing progress there, for sure.

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

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Okay. Okay. I did notice during the quarter, it seems like acquisition-related costs and profitability improvement costs came down, almost eliminated, if you will. Are there other -- do you see that coming back up in the out quarters or for the year? Or do you feel like you've kind of made all the moves that you need to make in that department?

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

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Let's talk about acquisitions first. I mean, obviously, if we did an acquisition, we'd have some additional acquisition costs, but we have nothing pending that would significantly impact the P&L. And last year, very quickly, we took actions to reduce our costs as soon as we saw the declining revenues. Again, we have nothing planned this year, so we don't anticipate any costs there. But I -- it's a very challenging environment, so I wouldn't rule that out if things went -- or declined further. But we have nothing planned.

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

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Okay. Okay. And then I guess last from me, the free cash flow profile is looking really strong. Maybe a 2-part question. One, is that CapEx number that you gave us majority growth CapEx? And then two, with this free cash, what are your kind of plans going forward? Dividend, share repurchases, et cetera?

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

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Sure. The majority (inaudible), but the majority of the $48 million is for growth. And as you know, all the programs take a fair amount of capital to launch, and we've got launches going on throughout the year here, so it's a good portion of that. I'm drawing a blank on the use for cash. Yes, Ron will answer that

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

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So we're -- yes. So we're certainly looking at just growing our business, deleveraging until we get -- to support organic growth and to support the growth of the business and possible future acquisitions, and until then, just deleverage. So no -- we pay a quarterly dividend and have for many years, and we will continue to return capital to the shareholders in that regard. But mostly, we would focus on future growth, organic and inorganic.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [11]

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Yes. And our -- until we find appropriate acquisition, our mission is to reduce the -- our debt. I think that's the best way of serving the shareholders is let's get our debt down even further.

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [12]

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Yes, it's a good point. And then at 1.6 debt-to-EBITDA ratio, we get it to 1.5. We then get some relief on our interest rate and unused line fees. So that's a pretty big number for us that we want to get to do as quickly as we can.

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Operator [13]

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(Operator Instructions) We'll go next to Steve Dyer, Craig-Hallum Capital Group.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [14]

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Ryan Sigdahl on for Steve. So you mentioned the Generation II Dabir system for patient care areas outside of operating room. Do you expect a similar ramp, I guess, as the legacy product there? Or are there different structural dynamics between an operating room versus other patient care areas of a hospital?

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

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No. Gen II was developed, as we said, for the patient care areas, but also to go into post acute. It is a -- I mean, it's just a more advanced system that we have. With Generation I, Generation I will continue to be used in operating rooms. We're not obsoleting that. It's just we felt that we needed a smaller -- and a portion of Gen II is battery operated lithium-ion. And so it doesn't really change the basic therapeutic value. It's just a different controller.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [16]

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So there is no reason to believe that you could launch faster or expand in the hospitals quicker with this new Generation II product?

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

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It was designed with a lot of input from post acute and what we learned from Gen I. I don't think that would accelerate Dabir's adoption. It's -- Dabir, as we've said, is a design and sell. You really have to go and improve the efficacy of the product, whether it be Gen I or Gen II. Now...

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [18]

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(inaudible) yes, go ahead.

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

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Let me -- another point there. When you go into ICU, you go into med-surg, there are more -- there's obviously more beds, so there's a larger available market. But again, I don't think that Gen II enables that. It's just us doing the design, and that we continue to do in the operating rooms. I'm sorry I interrupted you.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [20]

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Yes, no. I was just going to ask one. So presumably, the Gen I in the operating room has proved out efficacy and et cetera. Will that carry over? Or do you need to go kind of start from step one here with this product? Or can you use some of that -- leverage some of that previous experience there with this product?

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

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In a hospital that has used Gen I in the operating room, no, you don't have to go through another trial. The efficacy is proven now. We're doing a trial now in a new hospital system, and they decided they wanted to use it in ICU first versus operating room, and again, that's a new opportunity, so it's a new trial. But presumably, that trial will be successful. If they wanted to use it in another area if they wanted to go into the operating room, they would do another trial.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [22]

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Got it. I'll leave it there with Dabir. Switching over to industrial. Margins were really solid, 37.4% in the quarter. Where do you think that can go over the next few quarters kind of with all the crosscurrents with a bunch of synergy potential, but also a softening in the commercial market, et cetera?

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

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That's a very good question. And we are going to see softening in the commercial market. That's built into our second half. That does impact the margins. We have a number of cost improvement programs going on, particularly in our Chinese operation for Grakon. Some of those will offset that reduced margin from volume, but I don't -- I wouldn't anticipate that we're going to see higher than what we forecasted. There's just too many headwinds. That may help in '21, but I don't see that -- we'll hold our own, let's put it that way, by the initiatives. That was our design. And Ron, I don't...

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [24]

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Yes, I would just add to that, maybe that Hetronic is part of that group 2 as well, so any headwinds there could degrade the margins a little bit. It was a great quarter, as you know, the 37 -- over 37% margin. And I think our target, we had low to mid-30s. So that's -- we really -- we crushed it this quarter, for sure.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [25]

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And we have seen some softening in Hetronic European business. Now we think that will continue into the second quarter. We'll see what happens in Q3 and Q4. But we're seeing some softening there. That's a very good margin product for us, so if we see decline, then that obviously affects margins.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [26]

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And maybe just to clarify. I think I heard 2 different things there, that this year, you'll realize all the headwinds, but potentially, that margins could expand next year fiscal '21 and going forward. But I also heard kind of low to mid-30% gross margin. So maybe I guess...

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

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Well, I think...

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Ronald L.G. Tsoumas, Methode Electronics, Inc. - VP of Corporate Finance & CFO [28]

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That's what we've communicated.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [29]

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Yes, we've communicated as our target -- as the target this quarter was obviously higher than that. But as I said, there's pressures on that margin.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [30]

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Got it. Last one for me, then I'll turn it over. So on Slide 8, showing the content on the 2 different EV vehicles between $200, $300. Maybe how does that compare to different platforms, say, GM's truck and SUV platform?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [31]

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If I look at the average sell price on -- and right now, we're a combination K2 and T1, it's around $150. So on a lot of volume. But what we've seen with PI, with Grakon and our own busbar business, we've been able to add content to these vehicles quite nicely. Now again, it's not 700,000 units you see from GM, but the average sell price is higher, and the margin is better.

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Operator [32]

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Mr. Duda, at this time, I have no other questions holding, I'll turn the conference back for any additional or closing remarks.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [33]

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All right. Thank you, Jess. We'll thank everyone for listening, and have a very safe and enjoyable Labor Day weekend.

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Operator [34]

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Thank you. Ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may disconnect your phone line at this time, and have a great day.