Methode Electronics, Inc. — Q1 FY2017 Form 10-Q
Reporting period: Three months ended July 30, 2016; comparison period ended August 1, 2015. Unaudited interim results. Methode designs and manufactures electrical, electronic, wireless, sensing and optical components and subsystems across Automotive, Interface, Power Products and Other segments.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $191.9 million | $203.3 million | Down 5.6% |
| Gross profit / margin | $54.1 million / 28.2% | $53.6 million / 26.4% | Profit up 0.9%; margin +1.8 points |
| Income from operations | $26.7 million | $30.4 million | Down $3.7 million |
| Net income | $21.2 million | $23.5 million | Down 9.8% |
| Diluted EPS | $0.57 | $0.60 | Down $0.03 |
| Operating cash flow | $34.4 million | $19.0 million | Up $15.4 million |
| Capital expenditures | $4.2 million | $5.9 million | Down $1.7 million |
| Cash and cash equivalents | $249.3 million | $227.8 million at April 30, 2016 | Up $21.5 million |
| Long-term debt | $54.0 million | $57.0 million at April 30, 2016 | Down $3.0 million |
Gross margin improved as product costs fell faster than sales, while selling and administrative expenses rose 18.1% to $27.4 million, increasing from 11.4% to 14.3% of sales. The effective tax rate declined to 20.6% from 23.9%. Quarterly dividends were $0.09 per share.
Material changes and segment results
- Automotive: Sales fell 3.9% to $147.1 million, chiefly from lower volumes in Europe and Asia. Operating income was essentially flat at $36.1 million; segment operating margin increased to 24.5% from 23.4%.
- Interface: Sales declined 2.4% to $32.9 million. The segment moved from $0.7 million operating income to a $0.7 million operating loss, primarily reflecting higher legal and stock-award costs and lower sales.
- Power Products: Sales dropped 27.3% to $12.0 million, mainly due to lower PowerRail, cabling and busbar volumes. Operating income declined to $2.5 million from $3.1 million, despite improved gross margin.
- Other: Operating loss remained $2.3 million; medical devices, inverters and battery systems had minimal sales.
Management attributed improved gross margin to commodity pricing adjustments, favorable input-cost and currency effects, overhead reductions, and a $1.0 million reversal of accruals for resolved Automotive customer commercial issues. Prior-year Automotive results included a $1.3 million import-duty refund. Lower volumes, higher legal costs and stock-based compensation, and lower interest income weighed on earnings. Hetronic-related legal fees were $4.3 million, versus $1.2 million in the prior-year quarter.
Liquidity, debt and cash flow
- Operating cash flow was $34.4 million; cash generation from changes in operating assets and liabilities was $3.8 million, compared with $11.1 million of cash use in the prior-year quarter, largely reflecting the timing of receivable collections.
- Cash was $249.3 million, of which $237.1 million was held outside the U.S. and deemed permanently reinvested, limiting its availability for domestic operations. Management said cash, expected operating cash flow and the credit facility should support current operations.
- The $100 million revolving credit facility matures September 21, 2017. Borrowings were $54.0 million, with $46.0 million available (excluding a potential $50 million increase). The rate was 1.5% plus LIBOR; the company reported covenant compliance.
- Financing cash use was $5.4 million, including $3.3 million in dividends and $3.0 million of principal repayment. No shares were repurchased in the quarter; the $100 million authorization runs through September 1, 2017, and $62.0 million had been used through July 30, 2016.
Outlook, risks and contingencies
The filing provides no specific revenue, earnings or margin guidance. Management noted that quarterly results can vary and identified customer concentration, industry demand, program launches, pricing pressure, foreign exchange, overseas operations, supply-chain disruption, material availability, technology and product risks, tax-rate changes, and European economic conditions (including the U.K. vote to leave the EU) as factors that may affect results.
The Hetronic dispute with former distributors and their affiliates remained in discovery; defendants have filed counterclaims. Methode said it believes reserves are adequate for litigation and claims, but outcomes cannot be determined. The company also disclosed that future changes in expected performance for its fiscal 2020 performance-based awards could produce material compensation-expense catch-ups or reversals.
Foreign-exchange sensitivity disclosures estimate that a 10% exchange-rate change could affect pretax income by $9.0 million and the translated value of net foreign investments by $36.4 million. Management estimated a one-percentage-point interest-rate change would not materially affect fiscal 2017 results at current and expected debt levels.
Investor verification checklist
- Assess whether lower sales volumes—especially Power Products and Automotive—persist, and whether the customer and vehicle-program concentration risk changes.
- Determine how much of the gross-margin improvement is repeatable versus attributable to favorable commodity effects and the one-time $1.0 million accrual reversal.
- Track Interface legal expenses, Hetronic litigation developments and potential financial exposure.
- Monitor stock-based compensation expense and performance assumptions for the fiscal 2020 awards.
- Review the location and accessibility of overseas cash, credit-facility maturity and covenant headroom.
- Check future currency exposure, customer demand, new-program execution and any quantified management outlook; this filing gives no specific guidance.