Methode Electronics, Inc. — Form 10-K Summary
Reporting period: Fiscal year ended April 27, 2019 (52 weeks), compared primarily with fiscal 2018 ended April 28, 2018. Although the request metadata refers to “2018 Q4,” this filing is an annual report for fiscal 2019; it also reports fourth-quarter results separately.
Business context and reporting period
Methode designs and manufactures electronic and electromechanical components and subsystems for automotive, industrial, interface and medical markets. Automotive remained its largest business. Fiscal 2019 included about seven and a half months of results from Grakon, acquired September 12, 2018 for $422.1 million net of cash acquired. The company reorganized its reportable segments following that acquisition; historical segment results were recast.
Financial performance and liquidity
| Metric | FY2019 | FY2018 |
|---|---|---|
| Net sales | $1,000.3 million | $908.3 million |
| Gross profit / margin | $265.8 million / 26.6% | $239.6 million / 26.4% |
| Operating income / margin | $106.8 million / 10.7% | $118.3 million / 13.0% |
| Income before taxes | $103.6 million | $123.8 million |
| Net income | $91.6 million | $57.2 million |
| Diluted earnings per share | $2.43 | $1.52 |
| Operating cash flow | $102.0 million | $117.8 million |
| Cash and cash equivalents at year-end | $83.2 million | $246.1 million |
Sales rose 10.1%, but acquisitions contributed $163.0 million; currency translation reduced sales by $9.9 million. Excluding acquisitions, currency translation and the accounting change for pre-production reimbursements, sales declined $48.3 million, mainly from lower pricing and volumes in Automotive and lower Interface volumes. ASC 606 moved $24.2 million of tooling reimbursements from revenue to cost of products sold, reducing reported fiscal 2019 sales without the same effect on gross profit.
Gross margin edged up, but operating income declined 9.7% as selling and administrative expenses and acquired-intangible amortization increased. Net income improved largely because fiscal 2018 included a $53.7 million tax charge related to U.S. tax reform: the effective tax rate was 11.6% in FY2019 versus 53.8% in FY2018. The fiscal 2019 rate also reflected a $4.8 million tax benefit from finalizing tax-reform estimates and $2.0 million of foreign investment tax credits.
Cash from operations fell $15.8 million, including a $42.2 million cash outflow from changes in operating assets and liabilities. Investing activities used $470.8 million, primarily for Grakon; capital expenditures were $49.8 million. The company reported $292.6 million of total debt, including $15.7 million current and $276.9 million long-term, versus $57.8 million a year earlier. Separately, $278.7 million of principal was outstanding under its revolving facility and term loan. The credit facility provides a $200 million revolver and $250 million term loan, matures in September 2023, bears variable interest, and was in covenant compliance at year-end. Management said cash, expected operating cash flow and committed credit were sufficient for current operations; $69.9 million of cash was held outside the U.S.
Material changes versus the prior period
- Grakon materially expanded Industrial and Automotive sales; Industrial sales rose 95.5% to $206.8 million, while Automotive sales increased 0.8% to $734.7 million.
- Automotive gross margin fell to 25.6% from 27.7%, and operating income declined to $126.3 million from $156.3 million, reflecting volume and mix pressures, higher expenses and stock-based compensation.
- Interface sales fell 21.2% to $57.7 million, and the segment shifted to a $0.3 million operating loss from $6.0 million of income, mainly due to appliance-program timing and lower legacy data-solution sales.
- Medical remained small, with $1.1 million of sales and an $8.6 million operating loss; the loss narrowed from $11.4 million.
- Debt, goodwill and intangible assets increased substantially following the Grakon acquisition. Goodwill impairment testing found no impairment at year-end.
In the fourth quarter of FY2019, sales were $266.0 million, gross profit was $70.6 million and net income was $22.6 million. In the fourth quarter of FY2018, the corresponding figures were $249.0 million, $61.9 million and $36.8 million; the prior-year quarter included unusual tax effects.
Outlook, commentary, risks and unusual items
The filing provides no formal revenue, earnings or margin guidance. Management stated that existing cash, anticipated operating cash flows and committed credit were expected to support current operations. Backlog was approximately $275.1 million at year-end, with most expected to ship in FY2020. Research and development expense was $41.2 million, up from $37.9 million.
- Fiscal 2019 included $15.4 million of Grakon acquisition-related costs, $6.9 million of cost-reduction and operational-profitability initiative costs, $3.5 million of Hetronic litigation expense, and $2.3 million of net tariff expense on imported Chinese goods. Grakon inventory purchase-accounting adjustments added $5.6 million to cost of products sold.
- Other income included $5.8 million of international government grant income, compared with $7.3 million in FY2018. A $7.4 million prior-period stock-compensation adjustment followed management’s revised estimate that the fiscal 2020 performance target was probable.
- GM and Ford represented 35.5% and 11.6% of fiscal 2019 sales, respectively. Dependence on these customers and on particular vehicle models exposes results to production schedules, pricing, model transitions and demand shifts.
- Other material risks include automotive cyclicality, price pressure, tariffs and trade disputes, foreign-currency movements, raw-material costs, acquisition integration, product launches, technology competition, supply-chain interruptions and cybersecurity. The company does not use derivative instruments to hedge currency, interest-rate or commodity risks.
- The Hetronic dispute remained pending, with trial set for February 2020. Management did not believe currently known legal proceedings would materially affect the company, but outcomes remain uncertain. Environmental remediation accruals were $1.1 million; costs could exceed accruals if remediation proves more extensive.
Important facts for investors to verify
- How much of future growth and profitability depends on successfully integrating Grakon, and whether acquired operations sustain their reported contribution.
- Whether underlying Automotive and Interface volumes, pricing and margins stabilize, given the reported declines excluding acquisitions and the customer concentration.
- Debt repayment capacity, variable-rate exposure and covenant headroom after the acquisition; management estimated a 1% rate increase would add about $2.8 million in annual interest expense.
- Cash conversion and working-capital trends, including the decline in operating cash flow and the large reduction in year-end cash.
- Potential outcomes and additional costs from the Hetronic litigation, tariffs, environmental remediation and tax examinations.
- Comparability of reported sales and margins following ASC 606 adoption and the associated reclassification of pre-production reimbursements.