Methode Electronics, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the three months ended July 28, 2018, Methode’s first quarter of fiscal 2019, compared with the three months ended July 29, 2017. Methode manufactures electronic and electromechanical components and subsystems across Automotive, Interface, Power Products and Other segments. The unaudited interim statements use U.S. GAAP.
Financial performance and liquidity
| Metric | Quarter ended July 28, 2018 | Prior-year quarter |
|---|---|---|
| Net sales | $223.4 million | $201.2 million |
| Gross profit / margin | $60.1 million / 26.9% | $55.6 million / 27.6% |
| Operating income | $28.7 million | $25.4 million |
| Net income | $23.7 million | $20.5 million |
| Diluted EPS | $0.63 | $0.55 |
| Operating cash flow | $20.0 million | $23.6 million |
| Capital expenditures | $18.2 million | $8.0 million |
Sales increased 11.0% and net income increased 15.6%. Gross margin declined 0.7 percentage points; net margin was approximately 10.6%, versus 10.2%. Automotive sales rose 12.0% to $175.3 million, Power Products rose 23.7% to $18.8 million, and Interface declined 1.4% to $29.0 million. Other generated $0.3 million of sales and a $2.1 million operating loss.
Cash and cash equivalents were $228.5 million at quarter-end, down from $246.1 million at April 28, 2018. Current assets were $523.9 million and current liabilities $136.8 million. Balance-sheet short- and long-term debt totaled $53.1 million; cash exceeded that amount by approximately $175.4 million. The company reported $30.7 million of net borrowings under credit facilities for market-risk disclosure and was compliant with its credit covenants. About $223.2 million of cash was held outside the U.S., including $65.2 million deemed permanently reinvested.
Operating cash flow was lower year over year, principally due to working-capital changes. Investing cash use was $18.2 million, all for property, plant and equipment, compared with $29.9 million in the prior-year quarter, which included the Procoplast acquisition. Financing cash use was $9.4 million, including $4.1 million of dividends and debt repayments. The company paid a quarterly dividend of $0.11 per share, up from $0.09.
Material changes and accounting matters
- Automotive growth included contributions from Pacific Insight and Procoplast, acquired in fiscal 2018. Automotive operating income fell 8.1% to $32.9 million, as acquired-business mix, pricing reductions and higher amortization weighed on margins.
- Power Products operating income increased 33.3% to $4.4 million, supported by higher busbar and electronic power-steering connector volumes. Interface operating income rose to $3.5 million from $0.4 million, aided by lower legal costs, radio-remote-control sales and favorable currency effects.
- Methode adopted ASC 606 on April 29, 2018 using the modified retrospective method; prior periods were not restated. The filing reports current-quarter sales of $223.4 million under ASC 606 and provides an ASC 605 comparison of $230.5 million, a $7.1 million difference. Adoption increased opening retained earnings by $0.1 million and changed the timing/classification of certain revenue and tooling reimbursements.
- Foreign-currency translation reduced comprehensive income by $17.9 million, versus a positive $24.6 million adjustment in the prior-year quarter; comprehensive income was $5.8 million versus $45.1 million.
Outlook, risks and unusual items
The filing provides no quantified near-term earnings or sales guidance. Management said cash balances, expected operating cash flows and committed credit facilities were expected to support current operations. The company’s August 20, 2018 agreement to acquire Grakon for approximately $420 million in cash, on a cash-free, debt-free basis, was a significant subsequent event. Methode planned to use approximately $140 million of cash and had lender commitments for a $250 million term loan and $200 million revolving facility; closing was expected in September 2018, subject to customary conditions, and was not subject to a financing condition. Completion, integration, synergies and post-acquisition performance remain uncertain.
Key disclosed risks include dependence on two large automotive customers, pricing pressure, automotive program launches and demand, foreign-exchange exposure, material and supply-chain costs, trade-policy changes, and the integration and performance of acquisitions. Management cited a 10% currency-rate movement sensitivity of $1.8 million to pretax income and $52.4 million to the translated value of foreign net investments. A long-running Hetronic-related lawsuit and counterclaims remained in pre-trial proceedings; management stated it believed reserves were adequate. The company reported no material changes to internal control over financial reporting and concluded disclosure controls were effective.
The filing contains a potential future compensation-expense change: after the Grakon announcement, management said it would reassess the probability level for performance-based awards tied to fiscal 2020 EBITDA following closing. Any resulting adjustment could be material.
Most important facts for investors to verify
- Reconcile the filing’s differing presentations of current-quarter cost of products sold and gross profit: the income statement gives $163.3 million and $60.1 million, while MD&A gives $163.4 million and $60.0 million.
- Assess comparable sales growth using the ASC 606 adoption disclosure: reported sales are $223.4 million, while the filing’s ASC 605 basis for the quarter is $230.5 million; prior-year results were not restated.
- Monitor Grakon closing, final financing terms, resulting leverage and liquidity, and integration outcomes.
- Track Automotive segment margins, customer concentration and pricing, along with foreign-currency and working-capital movements.
- Follow the Hetronic litigation and any changes to reserves, and the potential fiscal 2020 award-compensation adjustments.