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Edited Transcript of MEI earnings conference call or presentation 5-Mar-20 4:00pm GMT

Q3 2020 Methode Electronics Inc Earnings Call

Chicago Mar 27, 2020 (Thomson StreetEvents) -- Edited Transcript of Methode Electronics Inc earnings conference call or presentation Thursday, March 5, 2020 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

* Erin Alexandra Welcenbach

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

* Ryan Ronald Sigdahl

Craig-Hallum Capital Group LLC, Research Division - 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 2020 Third Quarter Conference Call. For this quarterly conference call, the company has prepared a PowerPoint presentation entitled to Fiscal 2020 Second (sic) [Third] Quarter Earnings, which can be found at methode.com in the Investor Relations section. As a reminder, this conference is being recorded.

This conference call does contain forward-looking statements, which should reflect management's expectations regarding future events and operation -- operating performances and speaks only as of 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 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 automotive, appliance, commercial vehicle, computer and communications industries; international trade disputes resulting in tariffs and our ability to mitigate tariffs; potential impact from coronavirus outbreak; timing, quality and cost of new program launches; ability to withstand price pressure, including pricing reductions; ability to successfully market and sell Dabir Surfaces products; currency fluctuations; customary risks related to conducting global operation; ability to withstand business interruptions; recognition of goodwill impairment charges; ability to successfully benefit from acquisitions and divestitures; investment in programs prior to the recognition of revenue; dependence on the ability and price of materials; fluctuation in our gross margins; dependence on our supply chain; income tax rate fluctuations; ability to keep pace with rapid technology changes; breaches in our information technology systems; ability to avoid design or manufacturing defects; ability to compete effectively; ability to protect our intellectual property; success in Grakon 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; ability to manage our debt levels and any restrictions thereunder; and cost and expenses due to regulation -- I'm sorry, regulations regarding conflict minerals.

At this time, I'd like to turn the conference over to Mr. Don Duda, President and CEO. 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, Tom, and good morning, everyone. Thank you for joining us today for our fiscal 2020 third 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.

Before I comment, I would like to note that our fiscal third quarter accounting period includes 14 weeks versus 13 weeks for the same period of fiscal 2019 and 40 weeks in the 9-month accounting period ending February 1, 2020, versus 39 weeks for the same period of fiscal 2019. Also, the fiscal 2020 year-to-date third quarter results include 9 months of Grakon activity as compared to 4.5 months of Grakon activity in fiscal 2019 year-to-date results.

To start, please turn to Slide 4. Methode's year-to-date revenue increased 10.8%. Our net income increased 35.2%, and our diluted earnings per share increased 35% for the 9 months ended February 1 of this fiscal year. On a non-GAAP basis, our adjusted net income increased 4.5% and adjusted diluted earnings per share is up 4.3%. These values exclude expenses for initiatives to reduce overall costs and improve operational profitability, acquisition-related costs, including purchase accounting adjustments and long-term incentive plan accrual adjustments in the applicable periods.

As you can see on Slide 5, our year-to-date revenue performance, which includes the adverse effect from the UAW labor strike at GM that occurred in our second quarter. Year-to-date performance benefited from an extra 4.5 months of Grakon activity and benefited from our new program launches and higher sales volumes of sensors and switches, which have offset the customer-delayed launch in our touch sensor unit as well as the negative effects from foreign currency exchange.

Our performance to date and our anticipated lower consolidated tax rate allows us to reaffirm our fiscal year guidance numbers as reported during our second quarter fiscal year 2020 earnings call and as shown on Slide 6. During the third quarter, new business wins and business development efforts in the automotive and industrial segments continue to capitalize on portable vehicle trends, including electrification, LED lighting and incorporation of sensors to augment safety. We are very pleased with our bookings of approximately $105 million in new and annual business thus far this fiscal year.

Referring to Slide 7. In the quarter, Methode has been awarded a torque sensor and complex insert-molded product for the power steering system of a all-terrain sport recreation vehicle worth $12 million annually. Our sensor detects the efforts the driver is exerting, while the steering -- while steering the vehicle and allows the system to adjust its power steering assistance in real time. We have secured additional steering angle sensor business within automotive OEM for $4 million annually. Our LED lighting solutions business continues to grow with several program wins, including overhead console lamps, puddle lamps and licensed plate lamps for automotive and strip lighting system for the interior lighting for a bus manufacturer. Methode's power solutions group continues to do in electric vehicles and hybrid electric vehicle business as well as new awards in the data center equipment space.

Moving on, I want to comment on the latest automotive trend of the center display, increasing in size and moving to smart services with more control functions being integrated into the display itself, such as infotainment. We anticipate in the future there will be fewer interior designs using traditional buttons and knobs. And perhaps more importantly, we expect this trend will result in much lower average selling prices for any integrated center assembly that is awarded. As it would be inappropriate for me to speculate about any of our customer-specific plans for their future platforms and while we expect no effect on our business in the near term, we want to mention that based on our multiyear planning, at this point, we expect this transition will, indeed, occur and expect that there will be less integrated center stack units in our business mix over the next 5 years.

However, as we've done successfully in the past, Methode has evolved its business with new technology and products, such as our unique sensors, interior and exterior LED lighting, our power solutions for electric vehicles, and we will continue to develop innovative user interfaces, such as overhead consoles, digital clusters, et cetera. Thus, we feel that going forward, our higher-margin product mix will more than offset any potential decline in operating income from what we must now consider a legacy product. I believe the aforementioned year-to-date bookings demonstrate our success in these areas.

Turning to Slide 8. I'm excited to mention that our new engineering center located in Bangalore, India has been completed, and our personnel moving from our previous location has settled in. We constructed the 50,000 square foot state-of-the-art facility for our 165 associates, adding testing capabilities as well as having space to house additional personnel as Methode's engineering needs to expand with our business growth.

Moving to Slide 9. Our sensor group continues with its development and commercialization of total loan sensor systems based on Methode's magnetoelastic technology. Some key engineering assessments are now complete, and we expect to supply engineering samples to a customer over the next few months. As noted previously, we are targeting light truck and commercial OEMs to implement the benefits that can be derived from this sensor when driving vehicles with trailers. In the third quarter, at Dabir, we added 8 new customers and completed 6 hospital evaluations and have 3 evaluations in process with several planed for the next quarter. Also, our battery-operated Gen II controller should be available by the end of this fiscal year.

As many of you are aware, our Hetronic business unit has been in litigation with the former reseller of Hetronic's products. A jury trial conducted in Oklahoma City where Hetronic's international headquarters are located concluded this week. The jury decided in our favor and awarded compensatory and punitive damages of approximately $114 million. Obviously, the jury verdict is a great development that we are excited about. While the amount of the verdict is substantial, the judgment isn't final, and we don't know whether there will be any adjustments to the amounts awarded by the jury as part of the final judgment or how long it will take for a final judgment be entered. In addition, defendants can appeal after the final judgment is entered. Once we have a final judgment, we will work with counsel to implement the verdict and begin collection efforts. So I caution there is no guarantee that the company will be able to collect or win, particularly in light of the fact that all of the defendants are located outside the United States.

Moving on and to conclude, given the global macro environment and significant headwinds faced by Methode throughout this fiscal year, I am pleased that our third quarter performance largely based on organic growth, fueled by new program launches in our sensor business, led to solid financial performance, and aided by excellent cash generation, we continue to deleverage reducing debt by over $100 million since the Grakon acquisition. That said, we remain cautious and mindful of the coronavirus situation.

At this point, I'll turn the call over to Ron who will provide more detail on our financial results. 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. As was mentioned in both the 10-Q and the press release, fiscal year '20 third quarter results include 14 weeks of activity as opposed to 13 weeks in the third quarter of fiscal '19, and fiscal year-to-date '20 third quarter results include 40 weeks of activity as opposed to 39 weeks in the fiscal '19 year-to-date third quarter figures. Also, fiscal year '20 year-to-date third quarter results include 9 months of Grakon activity as compared to 4.5 months in fiscal '19 year-to-date results.

Please turn to Slide 10. Third quarter sales increased 15.8% or $39 million to $285.9 million in fiscal '20 from $246.9 million in fiscal '19. Sales in the third quarter benefited from higher sales in the automotive segment. Foreign currency exchange continued to be a headwind as both the euro and RMB exchange rates were weaker than the prior year, reducing net sales in the quarter by $2.2 million.

On a GAAP basis, third quarter net income increased $10.5 million to $41.2 million or $1.09 per share from $30.7 million or $0.82 per share in the same period last year. Third quarter GAAP net income benefited from higher gross profit, lower interest and amortization expense, offset by higher income tax expense. In addition, we realized benefits from initiatives to reduce costs and improve profitability taken in fiscal 2019, which included lower expense for those actions in the current fiscal year versus last fiscal year.

Moving to margins on Slide 11. Third quarter GAAP gross margins were higher, but non-GAAP adjusted gross margins were flat year-over-year in fiscal '20. Third quarter GAAP gross margins benefited from increased automotive and sensor sales but were negatively impacted by foreign currency translation and lower radio remote control and appliance product sales. Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce cost and improve profitability and purchase accounting adjustments in the applicable periods.

Third quarter GAAP selling and administrative expenses as a percentage of sales decreased 180 basis points year-over-year, favorably impacted by lower expense for operational improvements, the benefit of those operational improvements, lower acquisition cost and lower stock-based compensation expense. Non-GAAP selling and administrative expenses as a percentage of sales, which exclude acquisition-related costs, expense for operational improvements and related costs in the applicable periods, decreased 120 basis points year-over-year in the third quarter of fiscal '20.

Moving to year-to-date margins on Slide 12. Year-to-date GAAP gross margins improved by 90 basis points, but non-GAAP adjusted gross margins declined 20 basis points year-over-year. Gross margins were impacted by the UAW labor strike at GM, the negative impact of foreign currency translation and lower radio remote control and appliance product sales. These items were partially offset by the benefit of a full year of Grakon sales and increased sensor sales. Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce costs and improve profitability and purchase accounting adjustments in the applicable periods.

Year-to-date GAAP selling and administrative expenses as a percentage of sales decreased 290 basis points year-over-year, positively impacted by the lower expense for operational improvements, the benefit of those operational improvements, lower acquisition costs, lower stock-based compensation expense and by selling and administrative 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 excludes acquisition-related costs, expense for operational improvements and stock-based compensation adjustments, slightly decreased by 30 basis points on a year-to-date basis.

Shifting to EBITDA on Slide 13. The company generated $58.7 million in the first -- in fiscal '20 third quarter versus $43.1 million in the same period last year. Adjusting for expenses for initiatives to reduce overall costs and improve operational profitability and acquisition-related costs in the applicable periods, third quarter fiscal '19 adjusted EBITDA was $49.5 million compared to $59.8 million in the current period. The increase is primarily attributable to higher gross profit during the period.

Moving to year-to-date EBITDA on Slide 14. The company generated $152.6 million in fiscal '20 versus $109.1 million in the same period last year. Adjusting for expenses for initiatives to reduce overall costs and improve operational profitability, acquisition-related costs and stock-based compensation accrual adjustments in the applicable periods, fiscal '19 adjusted EBITDA was $137.6 million compared to $154.2 million in the current year period. The improvement is primarily attributable to higher EBITDA from Grakon, 9 months of activity versus 4.5 months and new product launches, partially offset by the adverse impact from the UAW labor strike at GM.

A few other financial items to review. Year-over-year intangible asset amortization expense in fiscal '20 increased $3.2 million or 28.8% to $14.3 million due to amortization expense related to the Grakon acquisition, partially offset by lower amortization in the interface segment.

In fiscal '20, we invested approximately $35 million in capital expenditures, mainly to support programs and launches in North America and Europe and our facility expansion in India. Year-to-date depreciation expense for fiscal '20 was $21.7 million.

Our year-to-date tax rate of 14.1% benefited from the favorable adjustments due to U.S. tax reform from IRS regulations that were issued in December 2019. Excluding this impact, our year-to-date tax rate would have been approximately 17%. We anticipate the tax rate for the fiscal year to be approximately 16%, assuming no additional discrete items in the fourth quarter.

Let's move to Slide 15. Free cash flow for fiscal '20 was $94.4 million.

As shown on Slide 16, we have used some of our free cash flow to pay down debt. We paid down nearly $36 million in debt since the beginning of the fiscal year. And since the acquisition of Grakon, we've reduced our gross debt by $101 million. We ended the quarter with $80 million in cash. And our debt-to-EBITDA ratio, which is used for our bank covenants, stands at approximately 1.3.

Please move to Slide 17 to look at our key drivers to our anticipated EBITDA performance for fiscal '20. Looking at the EBITDA base on our $155 million of EBITDA in fiscal '19 and adding the EBITDA from a full year at Grakon, which is approximately $25 million; adding EBITDA from new automotive and laundry program launches of about $16 million; adding back the onetime cost we incurred in fiscal '19 for initiatives to reduce cost and improve profitability of about $11 million; adding back the onetime cost we incurred in fiscal '19 for acquisitions and restructuring of about $29 million; and increasing our anticipated government grant income by $4 million; and subtracting the net impact from the UAW labor strike at GM of approximately $7 million; and subtracting the impact of the loss of EBITDA from reduced passenger car sales and other items, which we estimate to be around $12 million. At this juncture, we believe there are more headwinds than tailwinds in the fourth quarter of fiscal '20, including the potential impact of coronavirus.

In conclusion, I'll finish up my remarks with guidance. Please turn back to Slide 6. 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, Form 10-Q and our fiscal '19 Form 10-K. As we announced this morning, we reaffirmed fiscal '20 sales guidance in the range of $1.1 billion to $1.13 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. For fiscal '20, we are estimating capital investment to be in the $45 million to $50 million range and depreciation and amortization to be between $49 million and $50 million. Finally, we expect fiscal '20 free cash flow, as defined as net income plus depreciation and amortization less capital expenditures, to be between $122 million and $136 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. Tom, we are ready for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from David Leiker with Baird.

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Erin Alexandra Welcenbach, Robert W. Baird & Co. Incorporated, Research Division - Analyst [2]

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This is Erin Welcenbach on for David. So my first question relates to just thinking about the cadence of the platform changeover that 1 of your key customers is seeing. I realize that's likely going to hit more in kind of the fiscal 2021 time frame. But basically, just wondering if you can kind of help us walk through what the quarterly flow might look like given there are likely to be some large fluctuations in terms of that changeover.

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

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Erin, generally, we don't comment on the customer's rollout because we'd be divulging their plans. I can't say a lot about that, but we're not forecasting any choppiness, other than the normal quarterly trends you'll see at -- in the holiday quarter. And so we're not forecasting any unusual dips or spikes.

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Erin Alexandra Welcenbach, Robert W. Baird & Co. Incorporated, Research Division - Analyst [4]

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Okay. That's helpful. And then just on your comments about being bullish on being able to replace that center stacks business. I guess can you just kind of talk about what specific product categories you're excited about? Maybe what products you have in development and any traction on some of those new business wins that can point to concrete evidence of being able to start to build that pipeline?

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

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Oh, as we said in the prepared remarks, we booked $105 million of new annual business so far this year, and we're not done yet. And those are in those areas I talked about, sensors and LEDs and electrification. That gives me great comfort that our strategy there is -- begin to pay off. And in auto, there's definite life cycles to products. Years ago, we made a lot of money by being on wheel switches and multifunction switches and moved over to center consoles as the wheels, which has got very price-sensitive, let's put it that way, to center consoles, and now we're moving to overheads. I think we're up to 8 programs on that now. Our sensors, which has taken a long time to develop, but it had a definite effect on this quarter. And then what's under development is our magnetoelastic sensors but we're calling tow load to assist the driver whether it be a light truck or a Class 8 truck in towing trailers. So I feel Methode's done what it does best, and that is to apply technology and to provide our customers solutions.

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Erin Alexandra Welcenbach, Robert W. Baird & Co. Incorporated, Research Division - Analyst [6]

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Okay. That's helpful. And then just my final question is with respect to the interface segment. Can you talk about how that launch of the laundry program is going? It sounds like that may have been pushed a little bit on the timing standpoint. But obviously, your commentary and your full year guidance is that you expect that to launch at previously communicated volumes. So just any additional perspective there?

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

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I think all we can say that it's launching slower than planned, but we expect that it will get on track. Again, a slower launch than we -- or slow launch than we anticipate. I think again, I really don't want to comment on our customers' launches. But again, it's been slower.

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Operator [8]

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We'll take our next question from Chris Van Horn with Friedman, Billings, Ramsey.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [9]

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So first, on coronavirus. Just any update to your supply chain or your customers over in Asia? And then have you put any of those impacts if they're material into your guidance?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [10]

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Any effect that we've seen and expect to see -- and we're down to 2 months in the quarter now, is built in. We've had some air shipments, but that's been offset by other corrective actions that we've taken. So we feel, for the quarter, we're in pretty good shape. Some of the things that we monitor, our workforce, we're up to 80% attendance in Shanghai now. And I think that was down to 60% at one point. And then -- and the Grakon facility in Dongguan at 75%. So we view that as a good sign. We have several weeks of Grakon material on the water. You can view that as maybe 6 weeks of supply, but then if there's still time to get that into the pipeline in the U.S. or in Europe. So we have a little bit of cushion there. We've taken all the normal actions that companies have taken. We banned travel, we severely limited domestic travel, obviously, in China, gloves and wipes and masks and so on. And we are monitoring temperature of the workers every 4 hours, and we've isolated from cell to cell with a screen. So we've done a lot to curtail the effect. And our supply chain, we've had minimal interruptions. Now I've got to caution that if this gets considerably worse, at some point, it's going to have an effect and probably not in year-end but perhaps in the first quarter, and we'll talk about that, if necessary, at that time.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [11]

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Okay. I just want to touch on orders and specifically, this torque sensor award. Is this -- was this a competitive win? Was this a new technology to this ATV power system -- power steering system? And then how -- where are you on -- like, what's the TAM potentially for that market if this is successful?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [12]

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Well, the TAM is probably a hard one because you really need to look at what altering vehicles, what the market is for that. I would call it, some -- short of calling it a niche, but it is a very specific application. We've had those before. We're on the Spyder motorcycle and have been since its inception. It's basically the same technology being used for another vehicle. Competitive-wise, I -- there probably isn't any competition. Probably shouldn't say that, but I don't think -- we've seen something like e-bikes, but nothing that performs as well as magnetoelastic. Magnetoelastic, and just in terms of the total market, it is application-specific. We've talked for years about transmissions. And again, that's been years and years and years of development. We still don't have a platform there. But it is the same technology that's being used on the electric bikes and again, the Spyder.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [13]

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Okay. Got it. And then one of the themes, obviously, in auto is around electrification. And I think you have some significant electric vehicle customers in your customer list. And I'm just getting a sense as are there adjacencies and other products that you're working on for that market? And how do you see that market evolving for you?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [14]

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It's evolving but probably a little slower than everyone would think. There's a lot of start-ups. And we went to the consumer electronics show where there was a lot of display and talk on electrification. So that's a growing area for us, but it's not something that is going to transform us overnight, let's put it that away. And we are well positioned with the busbar products. Most people that require a busbar for their battery bank will contact us. We've talked about the major -- I don't want to use the name but the major EV manufacturer or all their platforms. Going forward, beyond the busbars, battery distribution modules, we are working on those for customers. That's a logical extension of our technology and our capabilities. And we are in the LED lighting. And if you look at the power consumption in EV, you want to keep that as low as possible. So things that we are doing in lighting, say, from a lensing standpoint, reducing the number of LEDs, helps us secure the business because, again, we're supplying the busbar, we understand the technology in the EV and can help them save energy.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [15]

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Okay. Okay. So it sounds like the timing, it just depends on adoption of EVs. And you do have some new products for that category.

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [16]

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And I don't want to say that it's not growing. We can outpace growth by, as you said, new products. The more we do that, the larger that segment will become for us.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [17]

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Yes. Okay. And you've cited Grakon as a good tailwind to margins here. Is that the mix of the products? Is it some of the synergies, the cost controls that you were able to push through because of the acquisition? Is it volume-related? What's kind of driving that?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [18]

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Probably, the biggest -- well, first of all, that is a higher-margin business than auto. That's 1 of the reasons we were very interested in acquiring it. But I have to give our Shanghai team, which manages the plant and -- on the Grakon plant in Dongguan, all sorts of credit. They've taken out millions of dollars of expenses just by doing what -- again, what Methode does well is manage its factory. So that's improving our margins. And then while we can't point to anything large yet, bringing the Methode technology into the Grakon customers has been well received, and we'll have to work through the product cycles and all the normal development protocols, but that will help us long term. Now we've seen reductions because of the Class 8 usage, but that -- we anticipate that will be relatively short-lived and any really, decline in that is probably going to be offset by our new products and our margin improvements.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [19]

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Okay. Great. Last one for me. It's nice to hear that the Hetronic trial might be coming to a close. Any sense for the timing of the resolution of how you get paid and when you get paid on those damages?

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Donald W. Duda, Methode Electronics, Inc. - President, CEO & Director [20]

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It's almost impossible to tell right now. I'm not filling out the deposit slip yet. But obviously, we're going to pursue that. That lawsuit was -- while it was expensive, it was necessary to preserve the business, which is what we've done, and now we'll work to implement the verdict and collect their moneys. Then -- at the timing, I -- that's very difficult. I really wouldn't want to speculate on the timing. That's probably the best I can answer there.

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Operator [21]

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We'll take our next question from Ryan Sigdahl with Craig-Hallum.

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

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Congrats on the really strong quarter and being able to maintain the guidance in this challenging environment. Maybe to start just on the guidance. I mean it seems like global auto production forecasts have been weakening almost by the day, plus you have coronavirus impacts. So I guess, it seems like several material negatives versus the last quarter when you gave guidance. So what are the -- can you please explain the positive surprise, I guess, over the last couple of months and what the offset to those negatives are?

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

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Well, as I was talking about with Chris, we've had very good success. We're taking costs out of the Grakon factory, which, I would say, exceeded our expectations maybe 6 months ago. Class 8 decline, not as great as they think as some forecasted. And yes, volumes are down in auto, but our new launches, which we pointed to, I think, all year, the majority of those would start to ramp in the third and fourth quarters, and we've seen that.

Ron is it...

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

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Yes. I have a couple of things to the margin expansion as well. Compared to last year, consolidated margins are up year-to-date, almost 1%. Auto margins are -- have maintained well in spite of the challenges in auto. Our industrial group margins have gone up quite a bit. So all of those things together, and then a couple of the other things is, obviously, with our EPS and all that, we -- our tax rate is a little lower than we thought it might have been when we came out last June. We've done a nice job mitigating tariffs, and you start adding all of those things together, increased sensor sales, that product has increased year-over-year pretty significantly at higher margin, a lot of know-how, a lot of IP. So you add all those things together, and they make a cumulative impact that has been very favorable to the company operating in a difficult environment.

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

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And I'm going to also add that the new emission requirements in Europe probably weren't as negative as they have been. So that's been helpful.

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

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Great. I appreciate the color. And then switching over, can you elaborate on, I guess, why you guys think the center stack business will decline, and it's now a legacy product? I mean you're still in the process of ramping GM's next-gen kind of truck and SUV platform. So it seems like there would be 5-plus years of platform life, at least there on your primary award as well as others.

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

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We've been asked the question by investors. And we -- what we wanted to do was just get on the record what we think the trend is and maybe not so much the center consoles as buttons. Again, I went to the consumer electronics show, and I even got in a number of years, we've always had people who will go, but they report back. But if you look at the new AMGs where the instrument cluster is really coupled with displays and glass that runs almost over to the passenger, very few buttons. So that stuff is more of a trend. And then as you take discrete functions, I'd say, the radio, more and more, that's getting integrated into the center or into the display. And we don't make the display nor do we intend to do, so the average sell price is going down. And that's a trend we wanted to get out in the market. I don't know if there's -- yes, what we're saying is we're still launching, and you're right. But it's something we're seeing.

Is there a mega award out there? No, because the average sell price is going down, and the screen manufacturers like LG are really taking over the display. We make our money when we integrate. And there's a change that's happening over the next 5 years. Again, nothing tomorrow.

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Ryan Ronald Sigdahl, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [28]

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Yes. And that's maybe a good segue. I mean will you continue to bid and focus resources on winning and keeping future generations with existing customers? I realize that's 5-plus years away. Or is it better to shift those resources and focus now on some of those other kind of higher-margin, higher-growth product categories that you mentioned earlier?

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

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Well, look, I'll give you both sides of that. We certainly are going to bid. We have our margin rules. And when that falls below that, we'll ball out because, as you said, the resources, we're better off. In certain instances, taking those resources and putting to electrification or in the sensors, and we've done that all along. I mentioned earlier, I've got out of multifunction switches. They just got too price-sensitive. Well, the displays, if we don't make them in terms of make the margins that we want. But again, if -- we're certainly going to bid on those items that I'm not saying we're getting out of it. I'm just saying it's getting commodity-like, and I'd probably put it now, in fact, I did, in the legacy categories.

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

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All right. Then maybe last question on this, and I'll leave it. But is there any -- I mean you have your touch sensor technology. I mean it seems like screens and going away from knobs and switches could -- you could benefit there. Is there a way to integrate that and leverage that technology? And then secondly, you called out a digital cluster display last quarter, which seemed like kind of the new-and-improved center stack in future product. I guess is there opportunity there? And how do you think about kind of those 2 technologies?

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

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Let me answer that one first. It's very definitely, there's opportunity there. Now we are up against the screen manufacturers, but in certain instances, the OEM wants an integrator. And again, we make our money when we bring technology together for the customer. But the customer certainly can go directly to the screen manufacturer themselves, and we've seen them, seen some of that happen.

And the first question, touch sensor, yes. No, because touch sensor is for discrete applications. So 1 function, 1 button. So that doesn't really apply to the displays in vehicle. That's not a technology that would be applicable for the most chips. Actually, not chips, aces. And for the most part, it's built into the -- well, it is now built into the screen chip.

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Operator [32]

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And at this time, there are no further questions. Mr. Duda, I'd like to turn the call over to you for any closing comments.

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

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Thank you, Tom. We'll thank everybody for listening, and have a good day. Goodbye now.

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Operator [34]

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Ladies and gentlemen, this does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time, and have a great day.