Methode Electronics, Inc. — Form 10-Q Summary
Business context and reporting period
The filing covers the third quarter and first nine months of fiscal 2018, ended January 27, 2018, compared with periods ended January 28, 2017. Methode manufactures electronic and electromechanical components and systems, reporting Automotive, Interface, Power Products and Other segments. The period includes acquisitions of Procoplast (July 2017) and Pacific Insight (October 2017), both reported in Automotive.
Key financial metrics
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $228.0 million | $195.6 million | $659.3 million | $596.7 million |
| Gross profit / margin | $60.1 million / 26.4% | $53.4 million / 27.3% | $177.7 million / 27.0% | $163.0 million / 27.3% |
| Income from operations | $35.6 million | $29.1 million | $90.7 million | $84.8 million |
| Income before taxes | $39.1 million | $30.3 million | $93.0 million | $88.0 million |
| Income tax expense | $63.4 million | $6.6 million | $72.6 million | $18.3 million |
| Net income (loss) | $(24.3) million | $23.7 million | $20.4 million | $69.7 million |
| Diluted EPS | $(0.65) | $0.63 | $0.54 | $1.86 |
Q3 sales rose 16.6%; nine-month sales rose 10.5%. Automotive sales drove growth, including acquired-business revenue and favorable currency translation. Q3 operating income increased, but gross margin declined. Nine-month net income fell 70.7%, principally due to tax expense associated with U.S. Tax Reform.
Cash flow and liquidity: Nine-month operating cash flow was $87.1 million, versus $106.7 million. Investing cash outflow was $165.0 million, including $129.9 million net acquisition spending and $34.7 million of property, plant and equipment purchases. Financing provided $57.6 million, including borrowing proceeds; dividends paid were $10.6 million. Cash increased $10.0 million to $304.0 million. Current assets were $605.3 million and current liabilities $150.3 million. The company reported $118.9 million of short- and long-term debt on its balance sheet, compared with $27.0 million of long-term debt and no short-term debt at April 29, 2017. Of cash, $299.9 million was held outside the U.S. and considered permanently reinvested.
Material changes and management commentary
- Tax reform: Q3 includes a provisional $56.8 million tax charge: $52.6 million for the one-time tax on deemed repatriation of foreign earnings, payable over eight years, and $4.2 million to remeasure U.S. deferred tax assets. The company said estimates remain provisional and may change.
- Acquisitions: Procoplast and Pacific Insight contributed to Automotive growth; Pacific Insight contributed $22.0 million of Q3 revenue and $0.4 million of net income. Purchase-price allocations remain preliminary. Nine-month acquisition-related costs were $6.8 million in total, including $6.0 million of selling and administrative expense.
- Segment trends: Q3 Automotive sales rose 22.9%, while Interface sales declined 6.4% and Power Products sales declined 1.3%. Automotive operating income rose more slowly than sales, with margin pressures from acquired-business mix, warranty expense, pricing and currency. Higher copper costs weighed on Power Products margins. Interface’s nine-month sales decline primarily reflected the closure of the Connectivity business.
- Other items: Q3 other income included a $1.6 million gain on licensing rights and $3.6 million in international government grants. The nine-month period also included $3.6 million in grants. The quarter included a $6.0 million reversal of prior-period performance-award compensation expense; changes in future estimates could cause material expense adjustments.
- Outlook: The filing provides no numerical sales or earnings guidance. Management said adoption of Dabir Surfaces medical products by hospitals is slower and more gradual than expected. It no longer considers the fiscal 2020 EBITDA target of $221.0 million probable, but considers the $198.9 million threshold probable.
Risks, contingencies and liquidity considerations
- The company identifies dependence on two large automotive customers, vehicle-program volumes, pricing pressure, new-program launches, supply-chain and materials costs, foreign exchange and competition as important risks.
- Management believes existing cash, operating cash flow and committed facilities are sufficient for current operations, but most cash is outside the U.S. and permanently reinvested. The main credit facility had $95.0 million outstanding and matures in November 2021; the company reported compliance with its covenants.
- Foreign-currency movements could affect pretax income and the value of foreign net investments. The company estimated that a 10% exchange-rate change could affect pretax income by $5.1 million and foreign net investments by $61.9 million at quarter-end.
- Litigation includes the Hetronic/Fuchs dispute, which remained in pre-trial proceedings. Methode says it has adequate reserves for pending litigation and claims; outcomes remain uncertain.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the provisional $56.8 million U.S. Tax Reform charge, including the repatriation-tax estimate, changes as the company completes its measurement-period accounting.
- How much reported sales growth and future profitability depend on acquisitions, and whether acquired businesses meet integration and return expectations as purchase accounting is finalized.
- Whether Automotive and consolidated gross margins stabilize amid pricing reductions, warranty costs, currency impacts, acquired-business mix and commodity inflation.
- Progress in Dabir Surfaces adoption and the assumptions underlying the fiscal 2020 EBITDA threshold and related stock-award compensation estimates.
- Availability and practical use of overseas cash, debt levels and refinancing/covenant capacity, alongside the company’s ability to sustain operating cash flow and dividends.
- Developments in the Hetronic litigation and any material change in associated exposure or reserves.