Methode Electronics, Inc. — Q1 FY2020 Form 10-Q
Reporting period: The 13-week quarter ended July 27, 2019, compared with the 13-week quarter ended July 28, 2018. Methode is a global manufacturer of electronic and electromechanical components and subsystems. Results include Grakon, acquired in September 2018; the company’s reportable segments are Automotive, Industrial, Interface and Medical.
Financial results
| Metric | Q1 FY2020 | Q1 FY2019 |
|---|---|---|
| Net sales | $270.2 million | $223.4 million |
| Gross profit / margin | $75.8 million / 28.1% | $60.1 million / 26.9% |
| Operating income | $38.6 million | $28.7 million |
| Net income | $28.3 million | $23.7 million |
| Diluted EPS | $0.75 | $0.63 |
| Operating cash flow | $19.1 million | $20.0 million |
| Capital expenditures | $13.2 million | $18.2 million |
Net sales rose 20.9%; management attributed $54.3 million of the increase to Grakon and a $4.3 million reduction to foreign-currency translation. Excluding both, sales decreased $3.2 million. Gross margin expanded 1.2 percentage points, while net margin was 10.5% versus 10.6%. The effective tax rate rose to 20.5% from 16.0%.
Operating cash flow was lower despite increased net income, primarily reflecting working-capital outflows, including higher receivables and inventory and lower payables and other liabilities. Cash declined $9.4 million during the quarter to $73.8 million.
At July 27, 2019, total debt was $283.1 million, including $15.4 million current; cash was $73.8 million. The company reported $269.6 million of principal outstanding under its credit agreement, which includes a $200 million revolver and a $250 million term loan. The agreement matures in September 2023, and the company was in covenant compliance. The current ratio was approximately 2.6x, based on current assets of $461.3 million and current liabilities of $180.8 million.
Material changes and segment performance
- Industrial: Sales increased 119.9% to $70.8 million, primarily due to Grakon. Operating income rose to $16.5 million from $7.1 million; gross margin improved to 37.4% from 32.3%.
- Automotive: Sales increased 6.2% to $186.2 million, while operating income was nearly flat at $33.1 million. Gross margin declined to 25.5% from 26.8%, reflecting geographic mix, pricing and currency effects.
- Interface: Sales fell 17.3% to $12.9 million and operating income fell to $0.2 million, principally due to lower appliance and data-solution volumes and unfavorable mix.
- Medical: Sales remained $0.3 million; operating loss narrowed to $1.5 million from $2.1 million.
Grakon also contributed to higher amortization and interest expense: amortization increased to $4.8 million from $1.9 million, and net interest expense rose to $2.9 million from $0.2 million. Management said net income excluding Grakon and currency effects decreased $3.3 million, citing lower gross profit, higher interest and higher tax expense, partly offset by cost-reduction initiatives.
Outlook, risks and notable items
- No specific financial guidance was provided. Management said cash balances, expected operating cash flows and the committed credit facility should be sufficient to support current operations. Of quarter-end cash, $68.8 million was held outside the United States and management said it could be repatriated without material additional tax expense.
- Key risks include dependence on two large automotive customers, end-market and vehicle-program exposure, pricing pressure, tariffs and trade disputes, foreign-currency movements, supply-chain and commodity costs, technology and product risks, and indebtedness.
- The company estimated that a hypothetical 10% adverse currency move could have affected quarterly pretax income by $2.1 million. A 1% increase in credit-agreement interest rates was estimated to increase annual interest expense by $2.7 million.
- The company recorded $0.3 million of net tariff expense on imported Chinese goods in Industrial. It also reported a $1.6 million foreign-currency translation loss in comprehensive income.
- The Hetronic distributor litigation, including counterclaims, was set for trial in February 2020. The company reported adequate reserves based on information available; Hetronic-related legal fees were $0.8 million for the quarter.
- Adoption of the lease standard on April 28, 2019 resulted in recognition of right-of-use assets and lease obligations; management reported no significant effect on operating results or cash flows. The filing reported $26.8 million of operating lease liabilities at quarter-end.
Important facts for investors to verify
- How much of future sales and earnings growth is attributable to Grakon versus underlying performance, and whether Grakon’s expected integration benefits are being realized.
- Whether weakness in Interface and lower radio-remote-control volumes persist, and whether Automotive margins stabilize amid pricing, geographic-mix and currency pressures.
- Working-capital trends, particularly receivables and inventory, and the ability to sustain operating cash flow while funding capital expenditures and dividends.
- Debt repayment, variable-rate exposure and covenant headroom, especially given the acquisition-related borrowing and interest expense.
- Developments in the Hetronic litigation and any resulting financial or operational consequences.