METHODE ELECTRONICS INC (MEI) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included in this Annual Report. This discussion and analysis of our financial condition and results of operations also contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements because of a variety of factors, including those set forth under Item 1A, “Risk Factors” of this Annual Report. We undertake no duty to update any such forward-looking statements to conform to actual results or changes in our expectations.
Overview
Our Business
We are a leading global supplier of custom engineered solutions with sales, engineering and manufacturing locations in North America, Europe, Middle East and Asia. We design, engineer and produce mechatronic products for OEMs utilizing our broad range of technologies for user interface, LED lighting system, power distribution and sensor applications.
Our solutions are found in the end markets of transportation (including automotive, commercial vehicle, e-bike, aerospace, bus and rail), cloud computing infrastructure, construction equipment and consumer appliance. Our business is managed on a segment basis, with those segments being Automotive, Industrial, Interface and Medical. For more information regarding the business and products of these segments, see Item 1, “Business” of this Annual Report.
In the first quarter of fiscal 2024, we made the decision to initiate the discontinuation of the Dabir Surfaces business in the Medical segment. In October 2023, we sold certain assets of the Dabir Surfaces business, and no longer operate this business. For further information, see Note 3, “Acquisition and Disposition” to the consolidated financial statements included in this Annual Report.
On April 20, 2023, we acquired 92.2% of the outstanding shares of Nordic Lights. We acquired the remaining 7.8% of the outstanding shares of Nordic Lights in fiscal 2024. Accordingly, as of April 27, 2024, we own 100% of Nordic Lights. The results of operations of Nordic Lights are reported within the Industrial segment from the date of acquisition and were immaterial for fiscal 2023. See Note 3, “Acquisition and Disposition” to the consolidated financial statements in this Annual Report for further information.
On June 25, 2024, we announced the appointment of Jon DeGaynor as our new President and Chief Executive Officer, beginning July 15, 2024. Mr. DeGaynor, age 58, currently serves as non-employee Executive Chairman of Racing and Performance, Inc., an automotive performance systems supplier in the aftermarket space. He previously served as President and CEO of Stoneridge, Inc., a publicly traded global designer and manufacturer of highly engineered electrical and electronic systems, components, and modules for the automotive, commercial, off-highway and agricultural vehicle markets, from 2015 to 2023.
Trends Affecting Our Business
The following trends significantly impact the indicators discussed above, as well as our business and operating results. See the risk factors identified under Item 1A, “Risk Factors” of this Annual Report for more information.
Macroeconomic Conditions
The global economy continues to experience volatile disruptions including to the commodity, labor and transportation markets, arising from a combination of geopolitical events and various economic and financial factors. These disruptions have affected our operations and may continue to affect our business, financial condition and results of operations. As a result of continued inflation, we have implemented measures to mitigate certain adverse effects of higher costs. However, we have been unable to fully mitigate or pass through the increases in our costs to our customers, which will likely continue in the future.
Geopolitical Conditions
Russia’s invasion of Ukraine and the resulting economic sanctions imposed by the international community impacted the global economy and gave rise to potential global security issues that may adversely affect international business and economic conditions. Given our manufacturing operations in the Middle East and Asia, the continuation of the military conflict between Russia and Ukraine, the escalation or expansion of the Israel-Hamas war, or renewed terrorist attacks on Red Sea shipping, such as those by the Houthi, could lead to other supply chain disruptions, increased inflationary pressures, and volatility in global markets and industries that could negatively impact our operations. The full impact of the conflicts on our business operations and financial performance remains uncertain and will depend on future developments, including the severity and duration of the conflicts and their impact on regional and global economic conditions. We will continue to monitor the conflicts and assess the related restrictions and other effects on our employees, customers, suppliers and business.
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Global Supply Chain Disruptions
Although we saw improvements in our supply chain in fiscal 2024, including easing of the worldwide semiconductor supply shortage, new supply chain disruptions may occur in the future. In addition, we have experienced, and may continue to experience, business interruptions, including customer shutdowns and increased material and logistics costs and labor shortages. We continue to work closely with suppliers and customers to minimize the potential adverse impact from global supply chain disruptions. However, if we are not able to mitigate any direct or indirect supply chain disruptions, this may have a material adverse impact on our financial condition, results of operations and cash flows.
Consolidated Results of Operations
A detailed comparison of our results of operations between fiscal 2023 and fiscal 2022 can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our fiscal 2023 Annual Report on Form 10-K filed with the SEC on June 27, 2023.
The table below compares our results of operations between fiscal 2024 and fiscal 2023:
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 27, 2024 | April 29, 2023 | ||||||
| Net sales | $ | 1,114.5 | $ | 1,179.6 | ||||
| Cost of products sold | 935.7 | 915.5 | ||||||
| Gross profit | 178.8 | 264.1 | ||||||
| Selling and administrative expenses | 160.9 | 154.9 | ||||||
| Goodwill impairment | 105.9 | — | ||||||
| Amortization of intangibles | 24.0 | 18.8 | ||||||
| Interest expense, net | 16.7 | 2.7 | ||||||
| Other income, net | (0.6 | ) | (2.4 | ) | ||||
| Income tax (benefit) expense | (4.8 | ) | 13.0 | |||||
| Net (loss) income | (123.3 | ) | 77.1 | |||||
| Net income attributable to redeemable noncontrolling interest | — | — | ||||||
| Net (loss) income attributable to Methode | $ | (123.3 | ) | $ | 77.1 |
Net sales
Net sales decreased $65.1 million, or 5.5%, to $1,114.5 million in fiscal 2024, compared to $1,179.6 million in fiscal 2023. The decrease was primarily due to lower sales in the Automotive segment, partially offset by the acquisition of Nordic Lights, which contributed $85.1 million of net sales to the Industrial segment, and favorable foreign currency translation of $4.3 million. Net sales included customer cost recoveries from spot buys of materials and premium freight costs of $2.2 million in fiscal 2024, compared to $20.9 million in in fiscal 2023. Excluding the impact of Nordic Lights, foreign currency translation and customer cost recoveries, net sales decreased $135.8 million, or 11.7%.
Cost of products sold
Cost of products sold increased $20.2 million, or 2.2%, to $935.7 million (84.0% of net sales) in fiscal 2024, compared to $915.5 million (77.6% of net sales) in fiscal 2023. The acquisition of Nordic Lights and foreign currency translation accounted for $62.6 million and $3.0 million, respectively, of the increase. Excluding Nordic Lights and foreign currency translation, cost of products sold decreased $45.4 million. The decrease was primarily due to lower material costs as a result of a decrease in sales volumes, partially offset by higher wages, product launch costs, freight and restructuring and impairment charges. Restructuring and impairment charges included within cost of products sold were $1.7 million in fiscal 2024, compared to $0.4 million in fiscal 2023.
Gross profit margin
Gross profit margin was 16.0% of net sales in fiscal 2024, compared to 22.4% of net sales in fiscal 2023. The decrease in gross profit margin was primarily a result of lower sales and operational inefficiencies in the Automotive segment. The operational inefficiencies were caused mainly by planning deficiencies, inventory shortages, unrecoverable spot purchases and premium freight, and delayed shipments.
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Selling and administrative expenses
Selling and administrative expenses increased $6.0 million, or 3.9%, to $160.9 million (14.4% of net sales) in fiscal 2024, compared to $154.9 million (13.1% of net sales) in fiscal 2023. The acquisition of Nordic Lights and foreign currency translation accounted for $9.6 million and $1.7 million, respectively, of the increase. Excluding Nordic Lights and foreign currency translation, selling and administrative expenses decreased $5.3 million. The decrease was primarily due to lower acquisition costs related to Nordic Lights and lower stock-based compensation expense, partially offset by higher professional fees and restructuring and impairment charges. In fiscal 2024, acquisition costs for Nordic Lights were $0.5 million, compared to $6.8 million in fiscal 2023. Stock-based compensation expense was lower due to a $3.6 million reversal of expense due to forfeitures in fiscal 2024 and a reduction in the number of restricted stock units subject to expense in fiscal 2024. The increase in professional fees was due to higher audit and consulting fees. Restructuring and impairment charges included within selling and administrative expenses were $2.0 million in fiscal 2024, compared to $0.5 million in fiscal 2023.
Goodwill impairment
In fiscal 2024, we recognized goodwill impairment of $105.9 million in the Automotive segment. For further information, see Note 6, “Goodwill and Other Intangible Assets” to the consolidated financial statements included in this Annual Report.
Amortization of intangibles
Amortization of intangibles increased $5.2 million, or 27.7%, to $24.0 million in fiscal 2024, compared to $18.8 million in fiscal 2023. The increase was due to the recognition of amortization expense associated with the acquisition of Nordic Lights.
Interest expense, net
Interest expense, net was $16.7 million in fiscal 2024, compared to $2.7 million in fiscal 2023. The increase was due to higher borrowings and increased interest rates.
Other income, net
Other income, net was $0.6 million in fiscal 2024, compared to $2.4 million in fiscal 2023. The decrease was due to lower international government assistance, partially offset by net gains on sale of assets and lower foreign exchange losses.
In fiscal 2024, we received $0.5 million of international government assistance, compared to $9.7 million in fiscal 2023. Fiscal 2023 international government assistance includes $6.3 million related to the COVID-19 pandemic and $3.4 million related to maintaining certain employment levels.
The net gain on sale of assets included a $2.4 million gain on sale of the company aircraft and a $0.6 million loss on the sale of certain assets of Dabir Surfaces.
Net foreign exchange loss was $2.2 million in fiscal 2024, compared to $7.1 million in fiscal 2023. Net foreign exchange losses were lower in fiscal 2024 due to higher efficiency in our foreign currency balance sheet remeasurement hedging program. In addition, net foreign exchange loss in fiscal 2023 included the recognition of $2.1 million of a foreign exchange loss reclassified from accumulated other comprehensive income as the result of a reorganization of a foreign owned subsidiary.
Income tax (benefit) expense
Income tax benefit was $4.8 million in fiscal 2024, compared to income tax expense of $13.0 million in fiscal 2023. Our effective tax rate decreased to 3.7% in fiscal 2024, compared to 14.4% in fiscal 2023. In fiscal 2024, the effective tax rate was favorably impacted by pre-tax losses in operations, the amount of income earned in foreign jurisdictions with lower tax rates of $5.1 million and research and development expenditures of $1.5 million. These were partially offset by non-deductible goodwill impairments of $22.7 million, withholding taxes of $3.2 million, and U.S. tax on foreign income of $3.5 million of which global intangible low-tax income is the main component. In fiscal 2023, the effective income tax rate was favorably impacted by the amount of income earned in foreign jurisdictions with lower tax rates and a tax benefit of $7.3 million associated with the reorganization of a foreign owned subsidiary, partially offset by a reduction in foreign investment tax credits of $5.0 million and non-deductible acquisition costs of $1.4 million.
Net (loss) income
Net loss was $123.3 million in fiscal 2024, compared to net income of $77.1 million in fiscal 2023. The acquisition of Nordic Lights contributed $3.9 million of net income and the impact of foreign currency translation increased net income by $0.3 million. Excluding Nordic Lights and foreign currency translation, net income decreased $204.3 million as a result of the reasons described above.
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Operating Segments
Automotive
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 27, 2024 | April 29, 2023 | ||||||
| Net sales | ||||||||
| North America | $ | 265.6 | $ | 349.0 | ||||
| Europe, the Middle East & Africa (“EMEA”) | 216.2 | 231.2 | ||||||
| Asia | 116.4 | 156.0 | ||||||
| Net sales | 598.2 | 736.2 | ||||||
| Gross profit | $ | 30.4 | $ | 126.2 | ||||
| As a percent of net sales | 5.1 | % | 17.1 | % | ||||
| (Loss) income from operations | $ | (140.2 | ) | $ | 67.0 | |||
| As a percent of net sales | (23.4 | )% | 9.1 | % | ||||
| Customer cost recoveries: | ||||||||
| North America | $ | 0.1 | $ | 9.7 | ||||
| EMEA | 0.9 | 3.7 | ||||||
| Asia | — | 0.6 | ||||||
| Total | $ | 1.0 | $ | 14.0 |
Net sales
Automotive segment net sales decreased $138.0 million, or 18.7%, to $598.2 million in fiscal 2024, compared to $736.2 million in fiscal 2023. Excluding foreign currency translation and customer cost recoveries, net sales decreased $127.7 million, or 17.7%.
Net sales in North America decreased $83.4 million, or 23.9%, to $265.6 million in fiscal 2024, compared to $349.0 million in fiscal 2023. Excluding customer cost recoveries, net sales decreased $73.8 million primarily due to lower sales volumes from program roll-offs, including a major center console program. Net sales in EMEA decreased $15.0 million, or 6.5%, to $216.2 million in fiscal 2024, compared to $231.2 million in fiscal 2023. The stronger euro, relative to the U.S. dollar, increased net sales in EMEA by $7.6 million. Excluding foreign currency translation and customer cost recoveries, net sales in EMEA decreased $19.8 million primarily due to lower sales volumes of sensor products. Net sales in Asia decreased $39.6 million, or 25.4%, to $116.4 million in fiscal 2024, compared to $156.0 million in fiscal 2023. The weaker Chinese renminbi, relative to the U.S. dollar, decreased net sales in Asia by $4.9 million. Excluding foreign currency translation and customer cost recoveries, net sales in Asia decreased $34.1 million primarily due to a program roll-off and lower overhead console sales volumes.
Gross profit
Automotive segment gross profit decreased $95.8 million, or 75.9%, to $30.4 million in fiscal 2024, compared to $126.2 million in fiscal 2023. Excluding the impact of foreign currency translation, gross profit decreased $96.7 million. Gross profit margins decreased to 5.1% in fiscal 2024, from 17.1% in fiscal 2023. The decrease in gross profit margins was due to lower sales volumes, increased costs for product launches, and operational inefficiencies in North America which led to planning deficiencies, inventory shortages, unrecoverable spot purchases and premium freight.
(Loss) income from operations
Automotive segment loss from operations was $140.2 million in fiscal 2024, compared to income from operations of $67.0 million in fiscal 2023. Loss from operations in fiscal 2024 includes goodwill impairment of $105.9 million. Excluding goodwill impairment and the impact of foreign currency translation, income from operations decreased $101.0 million. The decrease was primarily due to lower gross profit and slightly higher selling and administrative expenses. Selling and administrative expenses increased due to higher salary and incentive compensation expense, and outbound freight expense.
Industrial
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 27, 2024 | April 29, 2023 | ||||||
| Net sales | $ | 460.1 | $ | 384.9 | ||||
| Gross profit | $ | 137.7 | $ | 127.8 | ||||
| As a percent of net sales | 29.9 | % | 33.2 | % | ||||
| Income from operations | $ | 88.8 | $ | 93.1 | ||||
| As a percent of net sales | 19.3 | % | 24.2 | % | ||||
| Customer cost recoveries | $ | 0.8 | $ | 4.7 |
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Net sales
Industrial segment net sales increased $75.2 million, or 19.5%, to $460.1 million in fiscal 2024, compared to $384.9 million in fiscal 2023. The increase was primarily due to the acquisition of Nordic Lights, which contributed $85.1 million of net sales, and favorable foreign currency translation of $1.6 million, partially offset by lower customer cost recoveries from spot buys of materials and premium freight costs of $3.9 million. Excluding the impact of Nordic Lights, foreign currency translation and customer cost recoveries, net sales decreased $7.6 million, or 2.0%, primarily due to lower demand for power distribution products in the electric vehicle and data center markets and lower sales volumes of commercial vehicle lighting solutions products.
Gross profit
Industrial segment gross profit increased $9.9 million, or 7.7%, to $137.7 million in fiscal 2024, compared to $127.8 million in fiscal 2023. The increase was due to the acquisition of Nordic Lights, which contributed $22.5 million of gross profit, and $0.4 million of favorable foreign currency translation. Excluding the impact of Nordic Lights and foreign currency translation, gross profit decreased $13.0 million. Gross profit margins decreased to 29.9% in fiscal 2024, compared to 33.2% in fiscal 2023. Gross profit margins were impacted by lower sales volumes and higher operating expenses.
Income from operations
Industrial segment income from operations decreased $4.3 million, or 4.6%, to $88.8 million in fiscal 2024, compared to $93.1 million in fiscal 2023. The acquisition of Nordic Lights and favorable foreign currency translation accounted for $7.4 million and $0.2 million, respectively, of income from operations. Excluding Nordic Lights and the impact of foreign currency translation, income from operations decreased $11.9 million. The decrease was primarily due to lower gross profit, partially offset by slightly lower selling and administrative expenses. The decrease in selling and administrative expenses was primarily due to lower legal fees.
Interface
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 27, 2024 | April 29, 2023 | ||||||
| Net sales | $ | 53.8 | $ | 54.9 | ||||
| Gross profit | $ | 10.3 | $ | 9.3 | ||||
| As a percent of net sales | 19.1 | % | 16.9 | % | ||||
| Income from operations | $ | 6.9 | $ | 5.5 | ||||
| As a percent of net sales | 12.8 | % | 10.0 | % | ||||
| Customer cost recoveries | $ | 0.4 | $ | 2.2 |
Net sales
Interface segment net sales decreased $1.1 million, or 2.0%, to $53.8 million in fiscal 2024, compared to $54.9 million in fiscal 2023. Excluding customer cost recoveries, net sales increased $0.7 million, or 1.3%. The increase was primarily due to higher sales volumes of appliance products, partially offset by lower sales volumes of data solutions products.
Gross profit
Interface segment gross profit increased $1.0 million, or 10.8%, to $10.3 million in fiscal 2024, compared to $9.3 million in fiscal 2023. Gross profit margin increased to 19.1% in fiscal 2024, from 16.9% in fiscal 2023. The increase in gross profit margins was primarily due to higher sales volumes of appliance products.
Income from operations
Interface segment income from operations increased $1.4 million, or 25.5%, to $6.9 million in fiscal 2024, compared to $5.5 million in fiscal 2023. The increase was due to higher gross profit and lower selling and administrative expenses, primarily professional fees.
Medical
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 27, 2024 | April 29, 2023 | ||||||
| Net sales | $ | 2.4 | $ | 3.6 | ||||
| Gross profit | $ | (0.2 | ) | $ | (0.5 | ) | ||
| Loss from operations | $ | (3.0 | ) | $ | (6.1 | ) |
In the first quarter of fiscal 2024, we made the decision to initiate the discontinuation of the Dabir Surfaces business (which accounts for all of the Medical segment’s financial results). Towards the end of the second quarter of fiscal 2024, we sold certain assets of the Dabir Surfaces business and have now exited this business, which accounts for the variances in the table above.
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Financial Condition, Liquidity and Capital Resources
Our liquidity requirements are primarily to fund our business operations, including capital expenditures and working capital requirements, as well as to fund debt service requirements, dividends and stock repurchases. Our primary sources of liquidity are cash flows from operations, existing cash balances and borrowings under our senior secured credit agreement. We believe our liquidity position will be sufficient to fund our existing operations and current commitments for at least the next twelve months. However, if economic conditions remain impacted for longer than we expect due to supply chain disruptions, inflationary pressure or other geopolitical risks, or if we are unable to maintain compliance with our debt covenants, our liquidity position could be severely impacted.
At April 27, 2024, we had $161.5 million of cash and cash equivalents, of which $53.4 million was held in subsidiaries outside the U.S. Cash held by these subsidiaries is used to fund operational activities and can be repatriated, primarily through the payment of dividends and the repayment of intercompany loans, without creating material additional income tax expense.
Share Buyback Programs
On March 31, 2021, as subsequently amended on June 16, 2022, the Board of Directors authorized the purchase of up to $200.0 million of our outstanding common stock through June 14, 2024 (the “2021 Buyback Program”). On June 13, 2024, the Board of Directors authorized a new share buyback program, commencing on June 17, 2024, for the purchase of up to $200.0 million (the “2024 Buyback Program”) of our outstanding common stock through June 17, 2026. Purchases may be made on the open market, in private transactions or pursuant to purchase plans designed to comply with Rule 10b5-1 of the Securities Exchange Act of 1934. As of April 27, 2024, a total of 3,417,961 shares had been purchased under the 2021 Buyback Program at a total cost of $133.1 million since the commencement of that program. As of April 27, 2024, $66.9 million remained available under the 2021 Buyback Program to repurchase shares. Upon adoption of the 2024 Buyback Program, no further repurchases will be made under the 2021 Buyback Program.
Amended Credit Agreement
On October 31, 2022, we entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, and the Lenders and other parties named therein. The Credit Agreement amended and restated the Amended and Restated Credit Agreement, dated September 12, 2018 and as previously amended (the “Prior Credit Agreement”), with Bank of America, N.A., as Administrative Agent, Swing Line Lender, and L/C Issuer, Wells Fargo Bank, National Association, as L/C Issuer, and the Lenders and other parties named therein. Among other things, the Credit Agreement (i) increased the multicurrency revolving credit commitments under the Prior Credit Agreement to $750 million (which commitments were subsequently reduced, as discussed below), (ii) refinanced in full and terminated the term loan facility under the Prior Credit Agreement, and (iii) made certain other changes to the covenants, terms, and conditions under the Prior Credit Agreement.
As of January 27, 2024, we were not in compliance with the original consolidated leverage ratio covenant contained in the Credit Agreement for the quarter ended January 27, 2024. On March 6, 2024, we entered into a First Amendment to Second Amended and Restated Credit Agreement (the “First Amendment”) with Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, the other Lenders party thereto and other parties thereto. Among other things, the First Amendment (i) amended the consolidated leverage ratio covenant for the quarter ended January 27, 2024 and each subsequent fiscal quarter through the quarter ending October 26, 2024, (ii) amended certain interest rate provisions and (iii) waived any default or event of default that may have occurred due to the non-compliance with the consolidated leverage ratio covenant for the quarter ended January 27, 2024 that was in effect prior to the First Amendment. Following the effectiveness of the First Amendment, we were in compliance with the consolidated leverage ratio covenant for the quarter ended January 27, 2024.
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On July 9, 2024, we entered into a Second Amendment to Second Amended and Restated Credit Agreement and First Amendment to Second Amended and Restated Guaranty (the “Second Amendment”) with Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, the other Lenders party thereto and other parties thereto. Among other things, the Second Amendment (i) reduced the revolving credit commitments from $750 million to $500 million, (ii) granted a security interest in substantially all of the personal property of the Company and our U.S. subsidiaries that are guarantors, including 100% of the equity interests of their respective U.S. subsidiaries and 65% of the equity interests of their respective foreign subsidiaries (or such greater amount to the extent such pledge could not reasonably cause adverse tax consequences), (iii) amended the consolidated interest coverage ratio covenant for the quarters ending July 27, 2024, October 26, 2024, January 25, 2025 and April 26, 2025, (iv) amended the consolidated leverage ratio covenant for the quarter ending July 27, 2024 and each subsequent fiscal quarter, (v) amended certain interest rate provisions, (vi) added a requirement to provide monthly financial statements to the lenders through the period ending July 25, 2025, (vii) decreased the general basket exceptions to certain covenants restricting certain Company investments, liens and indebtedness for specified periods of time, (viii) increased, for fiscal year 2025, the general basket exception to a covenant restricting certain Company dispositions of property, (ix) added an “anti-cash hoarding” requirement, applicable during the period from the effective date of the Second Amendment until the earlier to occur of (a) the delivery of financial statements and a compliance certificate for the fiscal quarter ending July 25, 2025 and (b) the delivery of compliance certificates for two consecutive fiscal quarters demonstrating that the our consolidated leverage ratio as of the last day of such fiscal quarters was less than 3.00:1.00, that if we have cash on hand (subject to certain exceptions) of more than $65 million for 10 consecutive business days, we shall prepay the indebtedness under the credit facility by the amount of such excess and (x) made certain other changes to the investment, restricted payment and indebtedness baskets. We were in compliance with the consolidated leverage ratio covenant and consolidated interest coverage ratio covenant for the quarter ended April 27, 2024, both prior to and after giving effect to the Second Amendment.
The Credit Agreement, as amended by the First Amendment and the Second Amendment, is referred to herein as the “Amended Credit Agreement.”
The Amended Credit Agreement provides for a secured multicurrency revolving credit facility of $500 million. In addition, the Amended Credit Agreement permits us to increase the revolving commitments and/or add one or more tranches of term loans under the Amended Credit Agreement from time to time by up to an amount equal to (i) $250 million plus (ii) an additional amount so long as the consolidated leverage ratio would not exceed 3.00:1.00 on a pro forma basis, subject to, among other things, the receipt of additional commitments from existing and/or new lenders. The Amended Credit Agreement matures on October 31, 2027.
As of April 27, 2024, the outstanding balance under the revolving credit facility was $333.0 million, which included $294.0 million (€275.0 million) of euro-denominated borrowings. The Amended Credit Agreement contains various representations and warranties, financial covenants (including covenants requiring us to maintain compliance with a minimum consolidated interest coverage ratio and a maximum consolidated leverage ratio, in each case as of the end of each fiscal quarter of the Company), restrictive and other covenants, and events of default. The covenants in the Amended Credit Agreement include an “anti-cash hoarding” requirement, as discussed above. As of April 27, 2024, we were in compliance with all the covenants in the Amended Credit Agreement, both prior to and after giving effect to the Second Amendment. For further information, see Note 10, “Debt” to the consolidated financial statements included in this Annual Report.
Although we currently anticipate, based on our current projections and analyses, that we will be in compliance with the financial covenants contained in the Amended Credit Agreement, no assurance can be given that we will be and remain in compliance with such covenants in the future. Factors that could increase our risk of future non-compliance include those identified in Item 1A, “Risk Factors” of this Annual Report.
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Cash Flows
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 27, 2024 | April 29, 2023 | ||||||
| Operating activities: | ||||||||
| Net (loss) income | $ | (123.3 | ) | $ | 77.1 | |||
| Non-cash items | 147.0 | 59.2 | ||||||
| Changes in operating assets and liabilities | 23.8 | (3.5 | ) | |||||
| Net cash provided by operating activities | 47.5 | 132.8 | ||||||
| Net cash used in investing activities | (17.5 | ) | (153.1 | ) | ||||
| Net cash (used in) provided by financing activities | (18.9 | ) | 3.2 | |||||
| Effect of foreign currency exchange rate changes on cash and cash equivalents | (6.6 | ) | 2.1 | |||||
| Increase (decrease) in cash and cash equivalents | 4.5 | (15.0 | ) | |||||
| Cash and cash equivalents at beginning of the period | 157.0 | 172.0 | ||||||
| Cash and cash equivalents at end of the period | $ | 161.5 | $ | 157.0 |
Operating activities
Net cash provided by operating activities decreased $85.3 million to $47.5 million in fiscal 2024, compared to $132.8 million in fiscal 2023. The decrease was due to lower net income adjusted for non-cash items, partially offset by higher cash inflows related to changes in operating assets and liabilities. The $23.8 million of cash inflows for operating assets and liabilities in fiscal 2024 was primarily due to lower accounts receivable, partially offset by higher inventory.
Investing activities
Net cash used in investing activities was $17.5 million in fiscal 2024, compared to $153.1 million in fiscal 2023. In fiscal 2023, we paid $114.6 million of cash, net of cash acquired, for the acquisition of Nordic Lights. Capital expenditures in fiscal 2024 were $50.2 million, compared to $42.0 million in fiscal 2023. We received $21.3 million of cash from the sale of assets in fiscal 2024 compared to $3.5 million in fiscal 2023. In fiscal 2024, we redeemed life insurance policies and received cash proceeds of $10.8 million.
Financing activities
Net cash used in financing activities was $18.9 million in fiscal 2024, compared to net cash provided by financing activities of $3.2 million in fiscal 2023. In fiscal 2024, we paid $13.7 million of cash for share repurchases, compared to $48.1 million in fiscal 2023. We paid cash dividends of $19.9 million in fiscal 2024, compared to $19.8 million in fiscal 2023. In fiscal 2024, we had net borrowings of $30.7 million, compared to $73.7 million in fiscal 2023. Fiscal 2023 net borrowings were primarily to fund the acquisition of Nordic Lights. In fiscal 2024, we paid $10.9 million to redeem a noncontrolling interest.
Contractual Obligations
The following table summarizes our significant known contractual cash obligations and commercial commitments as of April 27, 2024:
| Payments Due By Period | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||
| Finance leases | $ | 0.5 | $ | 0.2 | $ | 0.3 | $ | - | $ | — | |||||||||
| Operating leases | 31.0 | 7.7 | 13.0 | 6.2 | 4.1 | ||||||||||||||
| Debt (1) | 334.5 | 0.2 | 0.4 | 333.5 | 0.4 | ||||||||||||||
| Estimated interest on debt (2) | 43.1 | 17.3 | 17.2 | 8.6 | — | ||||||||||||||
| Deferred compensation | 9.7 | 2.3 | 5.4 | 1.4 | 0.6 | ||||||||||||||
| Total | $ | 418.8 | $ | 27.7 | $ | 36.3 | $ | 349.7 | $ | 5.1 |
(1) Assumes the outstanding borrowings under the revolving credit facility will be repaid upon maturity of the credit agreement in October 2027.
(2) Based on interest rates in effect as of April 27, 2024 (including the impact of interest rate swaps).
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined under SEC rules.
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Legal Matters
For several years, Hetronic Germany-GmbH and Hydronic-Steuersysteme-GmbH (the “Fuchs companies”) served as our distributors for Germany, Austria and other central and eastern European countries pursuant to their respective intellectual property licenses and distribution and assembly agreements. We became aware that the Fuchs companies and their managing director, Albert Fuchs, had materially violated those agreements. As a result, we terminated all of our agreements with the Fuchs companies. On June 20, 2014, we filed a lawsuit against the Fuchs companies in the Federal District Court for the Western District of Oklahoma alleging material breaches of the distribution and assembly agreements and seeking damages, as well as various forms of injunctive relief. The defendants filed counterclaims alleging breach of contract, interference with business relations and business slander. On April 2, 2015, we amended our complaint against the Fuchs companies to add additional unfair competition and Lanham Act claims and to add additional affiliated parties.
A trial with respect to the matter began in February 2020. During the trial, the defendants dismissed their one remaining counterclaim with prejudice. On March 2, 2020, the jury returned a verdict in favor of the Company. The verdict included approximately $102 million in compensatory damages and $11 million in punitive damages. On April 22, 2020, the District Court entered a permanent injunction barring defendants from selling infringing products and ordering them to return Hetronic’s confidential information. Defendants appealed entry of the permanent injunction. On May 29, 2020, the District Court held defendants in contempt for violating the permanent injunction and entered the final judgment. Defendants appealed entry of the final monetary judgment as well. The appeal of the permanent injunction and the appeal of the final judgment were consolidated into a single appeal before the U.S. Court of Appeals for the Tenth Circuit. On August 24, 2021, the Tenth Circuit issued a decision affirming the lower court’s ruling with the exception that it instructed the District Court to modify the injunction from the entire world to all of the countries in which Hetronic sells its products. On April 20 and 21, 2022, the District Court held a hearing related to modifying the injunction pursuant to the Tenth Circuit’s opinion, and the parties filed post-hearing briefs. The defendants also filed a petition for certiorari with the United States Supreme Court seeking to further appeal the extraterritorial application of the Lanham Act in this case. The Company opposed that petition. The Supreme Court requested the views of the Solicitor General on the petition for certiorari, and the Solicitor General recommended granting the petition. On November 4, 2022, the Supreme Court granted the petition. The Supreme Court heard arguments in this matter on March 21, 2023. On June 29, 2023, the Supreme Court vacated the Tenth Circuit’s August 2021 decision and remanded the matter back to the Tenth Circuit for further proceedings. On September 1, 2023, the Tenth Circuit requested supplemental briefing from the parties regarding the effect of the Supreme Court’s decision on the appeal and the proper course of further proceedings. That briefing was thereafter submitted, and the Tenth Circuit heard argument in this matter on January 24, 2024. On April 23, 2024, the Tenth Circuit issued an opinion affirming the District Court’s final judgment on the state law breach of contract and tort claims (this affirmed final judgment amount represents only approximately $22.5 million of the vacated original $113 million final judgment that had been entered in 2020) and remanding for further non-trial proceedings with respect to the appropriate remedies for the Lanham Act claims in light of the Supreme’s Court ruling that the Lanham Act does not apply extraterritorially. On May 17, 2024, the District Court held a status conference and requested further briefing from the parties about the appropriate remedies for the Lanham Act claims.
Like any judgment, particularly a judgment involving defendants outside of the United States, there is no guarantee that the Company will be able to collect all or any portion of the judgment. Furthermore, defendants Abitron Germany and Hetronic Germany filed for insolvency in German court in September and October 2023 respectively, and the Germany insolvency court then appointed a receiver. These insolvency proceedings could potentially adversely impact our ability to enforce or collect upon the judgment or portions of the judgment or otherwise pursue or enforce claims or rights against those defendants.
We incurred legal fees of $2.5 million, $3.9 million and $3.3 million in fiscal 2024, fiscal 2023 and fiscal 2022, respectively, related to the lawsuits. These amounts are included in the selling and administrative expenses and as part of the Industrial segment.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with GAAP requires that we make estimates and assumptions that can affect amounts reported in the consolidated financial statements. In preparing our consolidated financial statements, we have made our best estimates and judgments of certain amounts included in the consolidated financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable. To the extent that there are differences between these estimates and actual results, our consolidated financial statements may be materially affected. We believe that of the significant accounting policies described in Note 1, “Description of Business and Summary of Significant Accounting Policies” to the consolidated financial statements in this Annual Report, the following involve a significant level of estimation uncertainty.
Goodwill. As described in Note 1 to the consolidated financial statements in this Annual Report, goodwill is tested for impairment on at least an annual basis, or more frequently if a triggering event indicates that an impairment may exist. In qualitatively assessing impairment, the primary qualitative factors include, but are not limited to, the results of prior year fair value calculations, changes in our market capitalization, the reporting unit and overall financial performance, and macroeconomic and industry conditions. We consider the qualitative factors and weight of the evidence obtained to determine if it is more likely than not that a reporting unit’s fair value is less than the carrying amount.
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For the quantitative assessment, we utilize either of, or a combination of, the income approach and market approach to estimate the fair value of the reporting unit. The income approach uses a discounted cash flow method and the market approach uses valuation multiples observed for the reporting unit’s guideline public companies. The determination of discounted cash flows are based on management’s estimates of revenue growth rates and earnings before interest, taxes, depreciation and amortization (“EBITDA”) margin, taking into consideration business and market conditions for the countries and markets in which the reporting unit operates. We calculate the discount rate based on a market-participant, risk-adjusted weighted average cost of capital, which considers industry specific rates of return on debt and equity capital for a target industry capital structure, adjusted for risks associated with business size, geography and other factors specific to the reporting unit. Revenue growth rates and EBITDA margin, especially in the outer years of a forecast, involve a greater degree of uncertainty. Further, a future change in the discount rate, as a result of a change in economic conditions or otherwise, could result in the carrying values of the reporting units exceeding their respective fair values.
We performed our annual goodwill impairment analysis for each of our reporting units at the beginning of the fourth quarter of fiscal 2024. Based on this analysis, we determined that the fair value of each of our reporting units was in excess of its carrying value. However, as noted in Note 7 to the consolidated financial statements in this Annual Report, the fair value of the Nordic Lights and North American Automotive (“NAA”) reporting units exceeded their carrying value by less than 10%. As discussed below, the NAA reporting unit goodwill was fully impaired as of April 27, 2024. We performed a sensitivity analysis for the significant assumptions used in the goodwill impairment testing analysis for the Nordic Lights reporting unit. The sensitivities were calculated in isolation using the income approach and keeping all other assumptions constant. The cash flow sensitivities do not consider the offsetting impact of a lower discount rate assumption to reflect the reduced risk in estimated future cash flow growth used under the income approach or the related impacts on pricing multiples used under the market approach.
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A hypothetical increase in the discount rate of 50 basis points would result in goodwill impairment of approximately $6.0 million; and
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A hypothetical decrease in cash flows of 10% over the entire forecast period would result in goodwill impairment of approximately $14.0 million.
In addition to our annual goodwill impairment analysis, we identified impairment triggering events at interim evaluation dates in fiscal 2024, which were associated with a sustained decrease in our publicly quoted share price, market capitalization and lower than expected operating results. We quantitatively assessed certain reporting units which performed substantially below the forecast used in our last quantitative impairment test. The reporting units that were quantitatively assessed were NAA and European Automotive (“EA”), and we determined the carrying value of these reporting units exceeded their fair value. As a result, in fiscal 2024, we recognized a total non-cash goodwill impairment charge of $105.9 million ($99.8 million for NAA and $6.1 million for EA) that reflected a full impairment of the related goodwill balances.
Impairment of long-lived assets. We evaluate whether events and circumstances have occurred which indicate that the remaining estimated useful lives of our intangible assets, excluding goodwill, and other long-lived assets, may warrant revision or that the remaining balance of such assets may not be recoverable. Determination of recoverability of long-lived assets is based on the lowest level of identifiable estimated future undiscounted cash flows resulting from the use of the asset and its eventual disposition. Measurement of any impairment loss is based on the excess of the carrying value of the asset group over its fair value. Assumptions and estimates about future values and the remaining useful lives are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts.
Income taxes. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. In calculating our effective income tax rate, we make judgments regarding certain tax positions, including the timing and amount of deductions and allocations of income among various tax jurisdictions. When determining whether we will be able to realize deferred tax assets, judgment is used to evaluate the positive and negative evidence, including forecasting taxable income using historical and future operating results.
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities. Our estimate of the potential outcome of any uncertain tax issue is subject to management’s assessment of relevant risks, facts, and circumstances existing at that time. We use a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We record a liability for the difference between the benefit recognized and measured and tax position taken or expected to be taken on our tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We evaluate our ability to realize the tax benefits associated with deferred tax assets by assessing the adequacy of future expected taxable income, including the reversal of existing temporary differences, historical and projected operating results, and the availability of prudent and feasible tax planning strategies. As of April 27, 2024, we had a valuation allowance of $5.8 million. In the event our operating performance improves or deteriorates in a filing jurisdiction or entity, future assessments could conclude a smaller or larger valuation allowance will be needed. Due to the complexity of some of these uncertainties, the ultimate resolution may be materially different from the current estimate.
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Some or all of management’s judgments are subject to review by the taxing authorities. If one or more of the taxing authorities were to successfully challenge our right to realize some or all of the tax benefit we have recorded, and we were unable to realize this benefit, it could have a material adverse effect on our financial results and cash flows. Further, if we are unable to generate sufficient future taxable income, there is a material change in the actual effective tax rates, a change to the time period within which the underlying temporary differences become taxable or deductible, or if the tax laws change unfavorably, then we could be required to increase the valuation allowance against deferred tax assets, resulting in an increase in income tax expense and the effective tax rate.
Business combinations. As described in Note 1 to the consolidated financial statements in this Annual Report, we account for business combinations using the acquisition method of accounting whereby the identifiable assets and liabilities of the acquired business, as well as any noncontrolling interest in the acquired business, are recorded at their estimated fair values as of the date that we obtain control of the acquired business. Determining the fair value of assets acquired and liabilities assumed requires management's judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows and discount rates, among other items.
We determine the fair values of intangible assets acquired generally in consultation with third-party valuation advisors. The fair value determination requires a number of judgments, particularly around forecasted revenue growth rates, customer attrition, and discount rates. For example and as discussed in Note 3 to the consolidated financial statements in this Annual Report, we recorded a customer relationships intangible asset in connection with the Nordic Lights acquisition of $77.3 million. We performed a sensitivity analysis for the significant assumptions used in the measurement of the customer relationships intangible asset. The sensitivities were calculated in isolation using the income approach and keeping all other assumptions constant. The sensitivity for the customer attrition rate does not consider the offsetting impact of a lower discount rate assumption to reflect the reduced risk in estimated future cash flow growth used under the income approach.
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A hypothetical increase in the discount rate of 100 basis points would result in a decrease in the valuation of approximately $6.3 million; and
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A hypothetical increase in the expected customer attrition rate over the entire forecast period of approximately 250 basis points would result in a decrease in the valuation of approximately $15.7 million.
If actual results are materially different than the assumptions we used to determine fair value of the assets and liabilities acquired through a business combination, it is possible that adjustments to the carrying values of such assets and liabilities will have an impact on net income.
New Accounting Pronouncements
For more information regarding new applicable accounting pronouncements, see Note 1, “Description of Business and Summary of Significant Accounting Policies” to the consolidated financial statements included in this Annual Report.
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