Earnings Call Transcript - MEI Q2 2020

Operator, Operator

Welcome to the Methode Electronics Fiscal Year 2020 Second Quarter Conference Call. For this quarterly conference call, the company has prepared a PowerPoint presentation, entitled Fiscal 2020 Second 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 reflects management's expectations regarding future events and operating performance and speak only as of the date hereof. These forward-looking statements are subject to a safe harbor protection provided under the securities laws. Methode undertakes no duty to update any forward-looking statements to conform the statements to actual results or changes in Methode's expectations on a quarterly basis or otherwise. Forward-looking statements in this conference call involve a number of risks and uncertainties. The factors that cause these actual results to differ materially from our expectations are detailed in Methode's filings with the Securities and Exchange Commission, such as our annual and quarterly reports. Such factors may include, without limitation, the following: dependence on a small number of large customers, including two large automotive customers; dependence on the automotive, appliance, commercial vehicle, computer and communications industries; international trade disputes resulting in tariffs and our ability to mitigate tariffs; 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 operations; ability to withstand business interruptions; recognition of goodwill impairment charges; abilities to successfully benefit from acquisitions and divestures; investment in programs prior to the recognition of revenue; dependence on the availability and price of materials; fluctuations in our gross margins; 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 Grakon 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. Operator Instructions. At this time, it is my pleasure to turn the floor over to Mr. Don Duda, President and CEO. Sir, the floor is yours.

Donald Duda, President and CEO

Thank you, Cynthia, and good morning, everyone. Thank you for joining us today for our fiscal 2020 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. To start, please turn to Slide 4. Although our second quarter and six month fiscal year-to-date results were adversely impacted by the 40-day UAW labor strike at General Motors, incremental sales from Grakon, revenue from new product launches, benefits from our initiatives to improve profitability and our continuous improvement actions to reduce costs improved Methode's year-over-year results on a GAAP basis. Methode's revenue increased 8.2%, our net income increased 36%, and our net income per share increased 35.3% for the six months ended October 26 of this fiscal year. Again, please refer to Slide 4 for our adjusted net income and adjusted income per share results, which 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 performance, excluding the adverse effect of the UAW labor strike at GM, still saw headwinds tempering our growth. Weaker auto sales, lower industrial equipment purchases and lower planned sales as well as the impact of weaker foreign currencies affected growth. However, with the strike behind us, the opportunities that we have going forward and our team's focus on our strategy, operational discipline and managing the business allows us to reaffirm our pretax income and EPS guidance for the fiscal year, as shown on Slide 6. Please note that we have reduced fiscal year 2020 revenue guidance largely due to the effect of the UAW labor strike. During the second quarter, new business wins and business development efforts in both the Automotive and industrial segments continued to capitalize on important vehicle trends, including electrification, LED lighting and safety. Methode has been awarded a custom complex insert molded product for a European vehicle manufacturer’s 48-volt powertrain system, launching mid fiscal year 2023 with an annual average revenue of $10 million. We've also been awarded an injection molded busbar and contact assembly for another European OEM's HEV 48-volt auxiliary battery pack for approximately $3 million per year, again, starting in fiscal year 2023. For the first time, Methode was awarded a digital cluster display and central display touchscreen with haptic feedback by a European premium luxury OEM for their next-generation vehicle. This key strategic win will launch in our fiscal year 2023. It is expected that this HMI solution, while small in initial revenue, will, over time, be carried across the customer’s other vehicle platforms, increasing revenue potential. Further, we believe the know-how and technology can be brought to other customers. Grakon and Pacific Insight continue to win several LED interior and exterior lighting programs for applications in automotive, commercial trucks, electric vehicles, buses and railcars, increasing their content per vehicle and per OEM customer, with some of these launches starting in our fiscal 2022. As noted on Slide 7, some of these wins are a result of cross-selling our technology. Specifically, Grakon is leveraging Pacific Insight's RGB LED light engine technology with commercial truck and electric vehicle OEMs. This technology was originally developed for the automotive market and provides Grakon customers with proven technology as well to further advance their features and customer offerings. I want to extend to the Grakon team my appreciation for their integration efforts and their focus on growing the business with booking awards of over $83 million since being acquired by Methode, which includes replacement and new business. Our magnetoelastic sensor business continues to grow, doubling the revenue on e-bikes this quarter versus last year. Also, our Eddy current sensor technology has been chosen for a European transmission position sensor, starting in the second quarter of fiscal year 2021 at approximately $2 million in average annual revenue. Moving to Slide 8. Our sensor group continued its development of a tow load sensor system based on Methode's magnetoelastic technology. Methode offers a sensor that provides real-time tow load and tow force data to the user and vehicle systems, which also improves drive stability. We are targeting light truck and commercial OEMs to implement the benefits that can be derived from the sensor when driving with a trailer. In the second quarter at Dabir, we added four new customers and completed nine hospital evaluations and five evaluations in process with several scheduled in the coming months. The Dabir development team is also in a human subject phase of testing of a new surface, with two hospitals that are targeting Dabir for use with pediatric patients. Successful testing and implementation will give Dabir another revenue path in the acute space. Turning to Slide 9. In summary, I am very pleased that Methode worked diligently to minimize the financial impact of the strike and the effect on our workforce. I would like to thank our worldwide team for their efforts and their focus on operational performance despite the many business challenges they faced. At this point, I'll turn the call over to Ron, who will provide more detail on our financial results.

Ronald Tsoumas, CFO

Thank you, Don, and good morning, everybody. Please turn to Slide 10. Second quarter sales declined 2.6% or $6.8 million to $257.2 million in fiscal '20 from $264 million in fiscal '19. Sales in the second quarter were negatively impacted from the UAW labor strike at GM, which reduced net sales by $32 million. Foreign currency exchange continued to be a headwind as the euro and renminbi exchange rates were weaker than the prior year, reducing net sales in the quarter by $3.9 million. This was partially offset by higher sales from Grakon of $32.3 million. Grakon was acquired in the second quarter of fiscal '19 and was included for 1.5 months versus the entire quarter this fiscal year. On a GAAP basis, second quarter net income increased $9.2 million to $23.8 million or $0.63 per share from $14.6 million or $0.39 per share for the same period last year. Second quarter GAAP net income benefited from the results of Grakon, lower acquisition-related costs, lower stock award amortization expense and the net benefit we received from initiatives to reduce costs and improve profitability, which included lower expense for those actions in the current fiscal year versus last fiscal year. On a non-GAAP basis, second quarter adjusted net income decreased $7.7 million to $24.2 million or $0.64 per share from $31.9 million or $0.85 per share for the same period last year. Negatively impacting second quarter GAAP and non-GAAP net income were the adverse impact of the UAW labor strike at GM of $9.6 million, higher expenses for net interest, intangible asset amortization, income taxes and net tariffs as well as the impact of foreign currency translation. China tariffs continue to be a headwind, although we're aggressively working to mitigate their impact on our results. In the second quarter, our net tariff expense was $600,000 and year-to-date net tariff expense was $900,000. This includes tariff revenue reimbursements related to fiscal '19, which were agreed to during the first quarter by some of our customers. Therefore, the amount recognized year-to-date does not represent a runway for the remainder of the year. We expect the net impact of tariffs to be higher for the remaining two quarters of fiscal '20, but lower than the $4.5 million to $5.5 million range we estimated during our first quarter fiscal '20 earnings call in August. Currently, we believe tariffs for the fiscal year will be in the range of $2.5 million to $3.5 million at the current tariff rate. Moving to margins on Slide 11. Second quarter GAAP gross margins were basically flat, but the non-GAAP adjusted gross margins declined 150 basis points year-over-year in fiscal '20. Current year gross margins were impacted by the UAW labor strike at GM, the negative impact of foreign currency translation and lower Radio Remote Control, busbar and appliance sales. This was partially offset by the benefit of Grakon sales. Non-GAAP adjusted gross margins exclude expenses for initiatives to reduce cost and improve profitability and purchase accounting adjustments in the applicable periods. Second quarter GAAP selling and administrative expenses as a percentage of sales decreased 530 basis points year-over-year, favorably impacted by lower expense for operational improvements, the benefits of those operational improvements, lower acquisition costs and lower stock-based compensation expense. However, non-GAAP selling and administrative expenses as a percentage of sales, which exclude acquisition-related costs, expense for operational improvements and stock-based compensation accrual adjustments in the applicable periods, increased 100 basis points year-over-year in the second quarter of fiscal '20. The increase was mainly attributable to lower sales as a result of the UAW strike at GM. Moving to year-to-date margins on Slide 12. Year-to-date GAAP gross margins improved 50 basis points, but the non-GAAP adjusted gross margins declined 30 basis points in the year-over-year in fiscal '20. Gross margins were impacted by the UAW labor strike at GM, the negative impact of foreign currency translations and lower Radio Remote Control busbar and appliance product sales. This was partially offset by the benefit of increased Grakon 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 350 basis points year-over-year, positively impacted by lower expense for operational improvements, the benefit of those operational improvements, lower acquisition costs for 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. However, non-GAAP selling and administrative expenses as a percentage of sales, which include acquisition-related costs, expense for operational improvements and stock-based compensation accrual adjustments in the applicable periods, slightly increased on a year-to-date basis. The increase was mainly attributable to lower sales as a result of the UAW strike at GM. Shifting to EBITDA on Slide 13. The company generated $43.6 million in the fiscal '20 second quarter versus $29.2 million in the same period last year. However, 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, second quarter of fiscal '19 adjusted EBITDA was $50 million compared to $44.1 million in the current period. The decrease is primarily attributable to the adverse effect from the UAW strike at GM, partially offset by higher EBITDA from Grakon. Moving to year-to-date EBITDA on Slide 14, the company generated $93.9 million in fiscal '20 versus $66 million in the same period last year. However, 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 $88.2 million compared to $94.4 million in the current period. The improvement is primarily attributed to higher EBITDA from Grakon, 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 $3.9 million or 69.6% to $9.5 million primarily due to amortization expense related to the Grakon acquisition. In fiscal '20, we invested approximately $27 million in CapEx 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 $14.2 million. Our year-to-date tax rate of 19.3% was impacted by discrete items recorded during the period. Excluding the impact of the discrete items, our year-to-date tax rate would have been approximately 18%, which is higher than the prior year due to the level of mix of earnings among taxing jurisdictions. Our expected rate for the remainder of this fiscal year is expected to be lower than we experienced year-to-date. Therefore, in spite of a higher anticipated effective tax rate, we estimate our tax rate will be in the range of 18% to 21% in fiscal '20. Let's move to Slide 15. Free cash flow for fiscal '20 was $49 million. As shown on Slide 16, we have used some of our free cash flow to pay down debt. We deleveraged nearly $18 million in debt since the beginning of the fiscal year, and since purchasing Grakon, we have reduced our debt by $83 million. We ended the quarter with $96 million in cash. Our debt-to-EBITDA ratio, which is used for our bank covenants, is approximately 1.5, which lowers our incremental borrowing cost by 25 basis points and 10 basis points on the commitment fee. Please move to Slide 17 to look at the key drivers to our anticipated EBITDA performance for fiscal '20. Looking at the EBITDA based on our $155 million of EBITDA in fiscal '19 and adding incremental EBITDA for a full year of Grakon, which is about $24 million; adding EBITDA from new automotive and laundry program launches of about $17 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; increasing our anticipated international government grant income by $4 million; and subtracting the net impact from the UAW labor strike of GM of $5 million; and subtracting the impact of the lost EBITDA from reduced passenger car production, which we estimate to be about $14 million. 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 pretax income in the range of $150.3 million to $164.3 million and earnings per share in the range of $3.25 to $3.55, but we believe there are more headwinds than tailwinds in the second half of fiscal '20. However, primarily as a result of the UAW labor strike at GM, we are revising our sales guidance to $1.1 billion to $1.13 billion from the prior sales guidance in the range of $1.13 billion to $1.17 billion. For fiscal '20 we are estimating capital investment to be in the $48 million to $54 million range and depreciation and amortization to be in the $51 million to $54 million range. We expect fiscal '20 free cash flow, as defined as net income plus depreciation and amortization less CapEx, to be between $122 million and $136 million. Finally, Methode's third quarter performance tends to not be as strong as its fourth quarter largely due to the holiday seasons and other factors. We anticipate the same holding true this fiscal year, with the fourth quarter expected to be stronger than the third quarter. Don, that concludes my comments.

Donald Duda, President and CEO

Ron, thank you very much. Cynthia, we are ready to take questions.

Operator, Operator

Our first question comes from Chris Van Horn of B. Riley FBR.

Christopher Van Horn, Analyst

Congratulations on strong performance in a tough environment. I wanted to quickly discuss guidance. The labor strike clearly impacted things, but regarding the underlying production estimates for automotive, are there any changes to your production expectations from IHS or LMC?

Donald Duda, President and CEO

No. We consider both factors. In the United States, we have a greater focus on trucks and SUVs, which we analyze closely, and those segments have remained strong. Removing the impact of the strike, we did expect some recovery in orders from our customers due to the UAW strike, albeit limited. In Europe, we keep a close watch on the situation on a weekly basis as it remains quite unpredictable.

Christopher Van Horn, Analyst

Got it. Got it. And as you look at kind of your awards that will be launching over the next, call it, 12 to 18 months, do you see a dramatic shift in your geographic mix as those launches happen?

Donald Duda, President and CEO

No, I don't see a significant geographic change. The number of launches in Europe is smaller, but there are more in the U.S. and a few in Asia with Great Wall.

Christopher Van Horn, Analyst

Okay. Got it. Margins are holding up really well, and I think Grakon is a significant factor in that. You're definitely implementing many initiatives on the cost side through operational efficiency and spending. Where do we stand on those cost-cutting initiatives? Is most of it completed? I understand there's always more to do, but it seems like you've significantly ramped it up over the past year. I'm just curious if you anticipate finding more opportunities for cost reduction as we look ahead to next year and what that might entail.

Donald Duda, President and CEO

First of all, I would say that we're ahead of where we thought we would be on the Grakon factory improvements. And kudos to the team in Asia, the Methode and the Grakon team. That certainly helped us, in the quarter. It will help us for the balance of the year. But I would say we're probably about halfway. It gets harder, initially, you're picking up dollars bills and eventually, you get down to pennies. But we anticipate that we've got another year of, I think, solid improvement there. And in the course of Methode, that's what we do for a living. And I know that's continuous improvement. But Grakon, we knew going into it that there were certain improvements we could make.

Christopher Van Horn, Analyst

Okay. That makes sense. Last for me. Congratulations on your digital cluster win. Not sure how much detail you can get into. I imagine you displaced the incumbent. And I'm just curious about any more detail. It seems like a new product line for you. There are many other players in the space that we can think of that are in the digital cluster arena. So any detail about what the award was or how it came it out? And maybe your competitive advantage in that win?

Donald Duda, President and CEO

I have to be cautious in what I say about the product and the customer. However, I can mention that this is a customer we have a good relationship with. We developed the technology around two to three years ago and are deploying it for the first time now. It makes sense considering we deployed center consoles on premium vehicles years ago before securing larger parts of the business. I would like to share more, as we are excited about it, but I cannot.

Christopher Van Horn, Analyst

Okay. Well, hopefully, maybe in the coming months or quarters, we can get some more detail around it.

Donald Duda, President and CEO

Yes, absolutely.

Operator, Operator

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

Ryan Sigdahl, Analyst

Congrats on the quarter. This is Ryan on for Steve. Just digging in the guidance, I guess, a little more. So you reduced revenue guidance by $35 million at the midpoint, primarily for GM, but you maintained the profitability expectations. Where are those cost cuts or efficiencies coming from, I guess, that you weren't expecting a couple of months ago when you last guided?

Donald Duda, President and CEO

Well, as I was talking with Chris a little bit ago, certainly from our Grakon cost improvement. That is ahead of schedule and that definitely helped. And Grakon sales were up. And we modeled Grakon sales both looking at what our customers are telling us, plus what we're seeing from ACT. And we were modeling a slight decline, and in fact it was better than we expected. We're still anticipating and modeled into our guidance a decline, but that didn't happen as fast as we thought. And again, kudos to the team, they have done an excellent job on tariffs. When we entered the year thinking around $8 million.

Ronald Tsoumas, CFO

8.5 million.

Donald Duda, President and CEO

And we're considerably below that. So all of that contributed to it.

Ryan Sigdahl, Analyst

Great. Then just switching over to Dabir. So in early October, you announced a master product agreement with Trinity Health, but then subsequently there was a notice to disregard. I guess just any way to clarify, I guess, what was going on with those press releases? And then as well as just if you could talk about the opportunity with that health system and then what that could potentially mean for any other hospitals, too?

Donald Duda, President and CEO

We should not have used their name, and they are clearly going to be a valuable customer. We wanted to quickly correct that, which we did. This marks our first system win, as most of our previous successes have been with individual hospitals, although they may be part of a larger system. The exciting aspect of this win is that Dabir will be implemented across their facilities, which is thrilling and a reason we wanted to share this with investors. While I can't disclose the revenue figure, it is likely to make Dabir our largest customer very soon.

Ryan Sigdahl, Analyst

As a follow-up question, will the deployment occur at each hospital individually, or is it more like a blanket approval for all hospitals? Will it be automatically implemented across all of their facilities?

Donald Duda, President and CEO

It’s likely a mixed situation. We will need to train each hospital, but they are starting to adopt Dabir. I don't want to imply that using it is mandatory, but it is integrated into their system. We will need to train the staff, and then it will be consistently used.

Ryan Sigdahl, Analyst

Great. One more for me and then I'll turn it over. So it looks like the auto and laundry launches is a couple of million worse than what you were expecting last quarter. Has there been another delay in that big product to launch there? Or what's going on?

Donald Duda, President and CEO

I would say that our auto launches are on time and on track. Laundry is still behind. And if I look at going forward, what risk is there, I mean, I suppose there can be further decline in the European auto market, but we really look at the laundry program as the biggest risk to that category.

Ronald Tsoumas, CFO

And these launches are more back-end loaded to the third and fourth quarter as well as they ramp up more towards the launch. So...

Operator, Operator

Our next question comes from David Leiker of Baird.

David Leiker, Analyst

I wanted to follow-up on a question a bit earlier on the digital cluster. I don't know if I missed it or if you didn't say it, did you put a dollar number on that?

Donald Duda, President and CEO

No, we didn't. But I can tell you, it's in the $1 million range. And then we expect it to be carried over to the other platforms.

David Leiker, Analyst

Okay. Great. Regarding the GM strike, where do you currently stand in terms of ramping up to full production after the strike?

Donald Duda, President and CEO

Let me answer this way, we are shipping everything the customer asked us to ship on time.

David Leiker, Analyst

Can you discuss the measures you implemented to reduce the effects of the strike? What portions were immediate tactical responses versus longer-term structural changes?

Donald Duda, President and CEO

We implemented several tactical measures with our workforce in Mexico. We responded quickly, taking action within 12 hours of the strike. Ron?

Ronald Tsoumas, CFO

We made several long-term structural changes, including a reduction in our workforce, which came with some associated costs. As Don mentioned, we found creative solutions within our workforce to minimize impacts, including the development of certain products to prevent future overtime when demand increases. We carefully considered these factors and successfully managed a challenging situation.

David Leiker, Analyst

Did you continue any production at all? I know you weren't shipping, but...

Ronald Tsoumas, CFO

Yes.

Donald Duda, President and CEO

Yes, we did. It was a fine line. You certainly don't want to lay off your workforce, especially since you're the only one being affected by it in that business park, as that could drive employees to the neighboring companies. So we blended vacation time with running production. Our plant is very clean, and a lot of things got painted. I want to emphasize that if the strike had continued into another week, our plan would have required us to take much more drastic measures, and thankfully, we didn't have to.

Ronald Tsoumas, CFO

A key takeaway is how competitive the market is for talented employees in that area. This was also part of our long-term strategy, ensuring that we retain our well-trained workforce for the future. All of these factors played a role in how we managed the situation.

Donald Duda, President and CEO

And David, we did have the advantage that since the major product that we produce there goes on trucks and SUVs, building some additional inventory didn't cause us as much of a concern, and that we know we will ship the product. If it was mainly passenger car you're not quite sure what platform. This, we can project out and do some, I would call them, strategic build. But again, we couldn't have gone much further.

David Leiker, Analyst

Okay. On Slide 17, you mention replenishment. Should I interpret that as revenue from the volume that GM lost during the strike?

Ronald Tsoumas, CFO

Yes, about 20% of the revenue lost during the strike is what we're addressing. We expect to recover a modest portion of that, estimating an EBITDA impact of approximately $2 million. While our replenishment strategy isn't overly aggressive, we do foresee some recovery of the lost sales.

David Leiker, Analyst

Great. And then on the contribution of the revenue from Grakon. How much of that could you call as still kind of the revenue from the acquisition just that wasn't in last year’s numbers versus growth you've had in Grakon since the purchase? Is there a way to characterize that?

Ronald Tsoumas, CFO

That would be...

Donald Duda, President and CEO

We'd have to compare.

Ronald Tsoumas, CFO

It would be quite challenging for us to do that right now.

Donald Duda, President and CEO

I think we can answer it, but we'd need to do a little research.

Ronald Tsoumas, CFO

Yes, it's right now.

Donald Duda, President and CEO

I can tell you it's higher than we anticipated and acquisition.

Ronald Tsoumas, CFO

Yes, no, for sure.

David Leiker, Analyst

Yes, Yes. Well, and you've done a great job there with the revenue performance versus the profit performance there, certainly driving that profitability higher. We're starting to see the commercial vehicle off-highway markets roll over a little bit. It seems like you're somewhat insulated from that. Or is that just being masked by the growth in other areas?

Donald Duda, President and CEO

No, it's in our plan. I don't know, we're definitely not masked by it. In round numbers, we're about 80% Class 8. Those have, let's say, flattened and not as down as maybe the lower classes. But we have modeled in pretty much in keeping with ACT. And again, we are correlating that with customer releases and our knowledge of the customers' needs and their inventory.

David Leiker, Analyst

Okay. Great. And then a couple of last items here. If we look at the appliance launches, it sounds like that's started, but it's just been slow so far. Is that the right way to characterize that?

Donald Duda, President and CEO

We are shipping, but at a very small rate at this point.

Ronald Tsoumas, CFO

That certainly poses a risk to our targets and EBITDA, specifically due to the potential for delayed or reduced volumes, as we've noted.

Donald Duda, President and CEO

We know they're going to continue with the other product, which is also in the pipeline. However, I believe that progress will be slower in the third quarter and increase in the fourth quarter. At this point, we can't specify how much, as we really don't have that information.

David Leiker, Analyst

So you don't have a lot of visibility from them in terms of what that ramp is going to look like at all still even though it started?

Donald Duda, President and CEO

That's correct. Clients tend to be a little different from auto, so they don't follow the auto launch rules.

Ronald Tsoumas, CFO

No. I think Grakon is a strong cash-generating business with very high margins. Having all of that with us now has definitely made a significant difference in many aspects, and this is further enhanced by the operational excellence mentioned earlier. All of that has translated into cash. We are effectively integrating that business into our operations and realizing the corresponding cash flows.

David Leiker, Analyst

Okay. Great. I usually don't congratulate people publicly on the phone, but you did a fantastic job on the cost side this quarter, so well done.

Donald Duda, President and CEO

Thank you very much, David. That's very much appreciated.

Operator, Operator

And there appear to be no further questions at this time. Mr. Duda, I will turn the conference back over to you, sir.

Donald Duda, President and CEO

Cynthia, thank you very much. And we'll thank everybody for listening, and wish you a very safe holiday and a good new year.

Operator, Operator

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time, and have a great day.