Methode Electronics, Inc. — Form 10-Q Summary
Reporting period: Third quarter and nine months of fiscal 2019 ended January 26, 2019. Financial statements are unaudited. Amounts are in millions of dollars except per-share data.
Business context
Methode manufactures electronic, electrical, sensing, optical and related component and subsystem products for automotive, industrial, interface and medical markets. In September 2018, it acquired Grakon, a custom lighting and engineered-components business, for $421.6 million net of cash acquired. The company reorganized its reporting segments in October 2018; historical segment information was revised. Fiscal 2019 results include Grakon only from its acquisition date, limiting period-to-period comparability.
Key financial metrics
| Metric | Three months ended Jan. 26, 2019 | Three months ended Jan. 27, 2018 | Nine months ended Jan. 26, 2019 | Nine months ended Jan. 27, 2018 |
|---|---|---|---|---|
| Net sales | $246.9 | $228.0 | $734.3 | $659.3 |
| Gross profit / margin | $64.3 / 26.0% | $60.1 / 26.4% | $195.2 / 26.6% | $177.7 / 27.0% |
| Operating income | $26.0 | $35.6 | $73.8 | $90.7 |
| Net income (loss) | $30.7 | $(24.3) | $69.0 | $20.4 |
| Diluted EPS | $0.82 | $(0.65) | $1.83 | $0.54 |
| Net interest expense | $3.2 | $0.3 | $5.0 | $0.3 |
| Income tax expense (benefit) | $(3.0) | $63.4 | $4.5 | $72.6 |
Third-quarter sales rose 8.3%, while gross margin declined 0.4 percentage points and operating income fell $9.6 million. Nine-month sales rose 11.4%, but gross margin declined 0.4 percentage points and operating income fell $16.9 million. Net income comparisons were strongly affected by the prior-year U.S. tax-reform charge; the company reported a $3.0 million tax benefit in the current quarter versus a $63.4 million expense a year earlier.
Cash flow and liquidity: Nine-month operating cash flow was $64.3, down from $87.1; capital expenditures were $37.0. Investing cash outflow was $458.3, including the Grakon acquisition. Financing cash inflow was $232.3, primarily reflecting $350.0 of borrowings and $103.3 of repayments. Cash ended the period at $73.7, down from $246.1 at fiscal year-end. Current assets were $446.4 and current liabilities $176.4. Of cash, $65.7 was held outside the U.S.; $41.7 of that amount was deemed permanently reinvested.
Debt: Balance-sheet short- and long-term debt totaled $302.9 at January 26, 2019, versus $57.8 at April 28, 2018. The amended credit agreement includes a $250.0 term loan and a $200.0 revolving facility, matures September 2023, and bears variable rates; the stated rate was LIBOR plus 1.50%. Outstanding balances were $246.9 on the term loan and $37.0 on the revolver. The company reported compliance with credit covenants. Additional subsidiary debt includes $2.9 short-term and $16.3 long-term at Procoplast.
Material changes and segment performance
- Automotive: Third-quarter sales fell 6.5% to $172.9 and operating income fell 31.5% to $27.0. Weaker passenger-car demand in Europe and Asia, price reductions and tariffs pressured results; North American sales included Grakon revenue.
- Industrial: Third-quarter sales more than doubled to $60.2 and operating income rose to $8.9, substantially reflecting Grakon, as well as stronger busbar and radio-remote-control sales. Industrial gross margin improved to 33.1% from 24.7%.
- Interface: Third-quarter sales declined 22.2% to $13.7, with operating income at break-even, mainly due to timing of an appliance program and lower legacy data-solution sales.
- Medical: Third-quarter sales were $0.1 and the segment reported a $1.7 operating loss.
- For the nine-month period, Industrial sales increased 83.9%; Interface sales declined 20.1%. Automotive operating income declined 18.1%, while Medical’s operating loss narrowed to $6.3.
Outlook, commentary, risks and unusual items
- No specific revenue, earnings or other forward guidance is provided in the supplied filing text. Management says cash, expected operating cash flows and committed credit are expected to support operations.
- Grakon contributed $46.9 of third-quarter revenue and $4.4 of net income. Its purchase-price allocation remains preliminary. The acquisition added $178.1 of goodwill and $218.9 of acquired intangible assets; resulting amortization and acquisition financing increased expenses.
- Third-quarter results included $3.8 of Grakon-related acquisition costs and $3.0 of acquisition inventory purchase-accounting charges. Management also identified $1.3 of costs from initiatives to reduce costs and improve operational profitability during the quarter.
- Other income included a $5.7 international government grant in the quarter. The current-quarter tax benefit included discrete tax adjustments; the prior-year period included substantial U.S. tax-reform charges.
- Management cited exposure to two large automotive customers, vehicle programs and industry demand; tariffs and trade disputes; pricing pressure; foreign-exchange movements; materials and supply-chain risks; acquisition integration and impairment risks; and execution of new program launches. A one-percentage-point interest-rate change was not expected to materially affect fiscal 2019 results at then-current debt levels.
- Hetronic-related litigation remained in the pre-trial stage, with counterclaims filed by defendants; the company stated it had adequate reserves for pending claims. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported sales growth and Industrial profitability is attributable to Grakon and other acquisitions, versus organic growth, and how the preliminary Grakon purchase accounting may change.
- Whether automotive demand, pricing pressure, tariffs and program mix continue to weigh on Automotive margins, and whether Interface sales recover after program timing effects.
- The sustainability of reported earnings given the material tax-rate differences, discrete tax items, government grants, acquisition costs and purchase-accounting charges.
- Debt repayment capacity, variable-rate exposure, covenant headroom, and the availability and location of cash, particularly cash held outside the U.S.
- Potential outcomes and costs of the Hetronic litigation, as well as execution and impairment risks associated with acquired goodwill and intangible assets.