METHODE ELECTRONICS INC annual report, FY2012

Business context and reporting period

Methode Electronics, Inc. designs and manufactures electrical, electronic, wireless, sensing and interconnect components and subsystems for automotive, industrial, communications and other markets. This is its Form 10-K for the 52-week fiscal year ended April 28, 2012 (fiscal 2012), not a standalone fiscal-quarter filing.

Its reportable segments are Automotive, Interconnect, Power Products and Other. Automotive supplied 58.0% of fiscal 2012 sales. Ford and GM, including sales through tiered suppliers, represented 18.7% and 18.5% of consolidated sales, respectively.

Financial performance and position

Current assets were $240.4 million and current liabilities were $91.9 million at year-end. The $75 million revolving credit facility matures February 25, 2016, bears interest at 1.5% plus LIBOR, and had $27 million available to borrow; the company reported compliance with its covenants. The company paid $10.4 million in dividends during fiscal 2012, or $0.28 per share.

Material changes versus the prior year

• Sales rose 8.6%, driven mainly by Automotive, up 20.2% to $271.6 million. Interconnect sales fell 8.0% to $127.7 million; Power Products rose 3.2% to $52.0 million; Other rose 6.9% to $13.9 million.
• Gross margin declined 2.9 percentage points. Management cited higher new-program development and launch costs, supplier production and delivery problems, and a higher share of automotive products with purchased content.
• Net income fell $11.1 million. Drivers included weaker gross profit, higher tax expense and launch-related costs, and the absence of fiscal 2011’s after-tax gain on the Optokon sale. Lower legal expenses partly offset the decline.
• Operating cash flow increased despite lower earnings, principally due to working-capital timing, including higher accounts payable and accrued expenses. Investing cash use rose to $32.1 million, including higher capital expenditures and the AMD acquisition.
• Fiscal 2012 included $3.7 million of pre-tax legal expense related to Delphi supply-agreement and patent litigation. Fiscal 2011 included $4.8 million of such expense and a $0.6 million after-tax Optokon sale gain.

Outlook, risks and contingencies

The filing provides no quantified earnings or revenue guidance. Methode expects production and sales from a next-generation GM center-stack program to begin in late fiscal 2013. It anticipates substantial equipment, tooling, inventory and staffing outlays before launch, and warned cash balances may decline before associated sales begin. Backlog was approximately $87.9 million at year-end, with most expected to ship in fiscal 2013.

• Customer and market concentration: Automotive represented 58% of sales, and Ford and GM together about 37%. Model-specific demand, customer production schedules, contract awards and automotive cyclicality can materially affect results.
• International exposure: Approximately 59% of sales came from international operations. Currency movements, European economic conditions, political and regulatory risks, and overseas cash availability may affect results. $79.3 million of cash was held outside the U.S.; management said most was considered permanently reinvested.
• Execution and cost risks: New-program launch expenses, vendor delivery issues, pricing pressure, product mix and material costs have affected margins. Fiscal 2012 saw price increases in some resins and silver; copper prices were described as stable.
• Legal matters: Delphi litigation includes a dispute over termination of a supply agreement and related intellectual property, and a bankruptcy preference-payment complaint seeking approximately $19.7 million. Management said reserves were adequate and did not expect the matters to materially adversely affect consolidated financial statements, while noting outcomes cannot be determined.
• Environmental matters: Remediation accruals were $2.9 million at year-end for two former sites. Costs could exceed accruals if remediation does not achieve regulatory targets.
• Tax and acquisition items: Fiscal 2012 tax expense was $3.2 million, including a deferred U.S. tax provision associated with a changed reinvestment assertion for foreign earnings, offset by a reduction in valuation allowance. The company acquired AMD for approximately $6.4 million and increased its Eetrex ownership to 90%; remaining Eetrex shares are subject to put options.

Management reported effective disclosure controls and internal control over financial reporting; Ernst & Young issued unqualified audit opinions on the financial statements and internal controls.

Most important facts for investors to verify

1. Whether the GM center-stack program launches on schedule and within budget, and whether launch costs and investment precede revenue as expected.
2. Whether gross margins recover as launch spending, supplier issues and automotive product mix change.
3. How much of reported cash is practically available to fund U.S. operations, given foreign cash balances and repatriation tax considerations.
4. Whether customer concentration, vehicle production volumes and program awards remain stable, particularly at Ford and GM.
5. Developments in the Delphi cases and environmental remediation, including any change in estimated exposure or reserves.