METHODE ELECTRONICS INC (MEI) FY 2022 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 U.S. 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
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, consumer appliance and medical devices. Our business is managed on a segment basis, with our four 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.
Impact of the COVID-19 Pandemic
The COVID-19 pandemic and the ongoing measures to reduce its spread have negatively impacted the global economy, disrupted consumer and customer demand and global supply chains, and resulted in manufacturing inefficiencies and increased freight costs due to global capacity constraints. We expect that the global health crisis caused by the COVID-19 pandemic will continue to negatively impact our business and results of operations for the foreseeable future. The extent of the impact will depend on a number of evolving and uncertain factors, including the duration and spread of COVID-19 (and its variants), the rate of vaccinations, actions taken by governmental authorities to further restrict business operations and social activity and impose travel restrictions, shifting consumer demand, the ability of our supply chain to deliver in a timely and cost-effective manner, the ability of our employees and manufacturing facilities to operate efficiently and effectively, the continued viability and financial stability of our customers and suppliers and future access to capital.
We continue to focus on effectively managing the unprecedented challenges and uncertainties of the pandemic on a global basis. Management has prioritized the health and safety of our employees and their families. We adopted numerous safety procedures at our global facilities, including hygiene and disinfection protocols, testing and contact tracing, social distancing and wearing personal protective equipment. We share best practices throughout our global facilities, resulting in effective and standardized safety guidelines and procedures, updated on a regular basis, promoting the health and safety of our employees.
Global Supply Chain Disruptions
We continue to experience business interruptions, including customer shutdowns and increased material and logistics costs, labor shortages, and most significantly, impacts from the worldwide semiconductor supply shortage. The semiconductor supply shortage is due, in part, to increased demand across multiple industries, including the automotive industry, resulting in a slowdown in their production schedules. The semiconductor supply shortage is also impacting our supply chain and our ability to meet demand at some of our non-automotive customers. We expect this semiconductor shortage to have a continued impact on our operating results and financial condition in fiscal 2023.
Restructuring Actions
In fiscal 2022, we initiated a restructuring plan to consolidate one of our operations within the Industrial segment in response to logistics issues and tariffs. This action resulted in a facility shutdown and consolidation of activities into an existing location. In fiscal 2022, we recognized $3.6 million of restructuring costs. We may take additional restructuring actions in future periods based upon market conditions and industry trends.
As a result of the COVID-19 pandemic, we initiated certain restructuring actions in fiscal 2021 to rationalize our operations, lower our costs and improve financial performance and long-term cash flow generation. These actions included plant consolidations and workforce reductions in the Automotive, Industrial and Interface segments. In fiscal 2021, we recognized $8.2 million of restructuring costs.
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Impacts of Macroeconomic and Geopolitical Conditions
Adverse macroeconomic conditions, including but not limited to inflation, slower growth or recession, new or increased tariffs, changes to fiscal and monetary policy, higher interest rates and currency fluctuations could adversely affect demand for our products. In addition, in February 2022, Russia invaded Ukraine resulting in, among other things, economic sanctions imposed by the international community which have impacted the global economy and given rise to potential global security issues that may adversely affect international business and economic conditions. Although we have no operations in Russia or Ukraine, certain of our customers and suppliers have been negatively impacted by these events, which in turn has impacted markets where we do business, including Europe and Asia. The economic sanctions imposed on Russia has further increased existing global supply chain, logistics, and inflationary challenges.
Consolidated Results of Operations
We maintain our financial records on the basis of a 52 or 53-week fiscal year ending on the Saturday closest to April 30. Fiscal 2022 ended on April 30, 2022 and fiscal 2021 ended on May 1, 2021, which represented 52 weeks of results for each year. Fiscal 2020 ended on May 2, 2020, which represented 53 weeks of results. The following discussions of comparative results among periods should be reviewed in this context.
A detailed comparison of our results of operations between fiscal 2021 and fiscal 2020 can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our fiscal 2021 Annual Report on Form 10-K filed with the SEC on June 24, 2021.
The table below compares our results of operations between fiscal 2022 and fiscal 2021:
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 30, 2022 | May 1, 2021 | ||||||
| Net sales | $ | 1,163.6 | $ | 1,088.0 | ||||
| Cost of products sold | 898.7 | 813.9 | ||||||
| Gross profit | 264.9 | 274.1 | ||||||
| Selling and administrative expenses | 134.1 | 126.9 | ||||||
| Amortization of intangibles | 19.1 | 19.3 | ||||||
| Interest expense, net | 3.5 | 5.2 | ||||||
| Other income, net | (10.3 | ) | (12.2 | ) | ||||
| Income tax expense | 16.3 | 12.6 | ||||||
| Net income | $ | 102.2 | $ | 122.3 |
Net sales
Net sales increased $75.6 million, or 6.9%, to $1,163.6 million in fiscal 2022, compared to $1,088.0 million in fiscal 2021. The increase was primarily due to higher sales in the Automotive and Industrial segments. The COVID-19 pandemic negatively impacted net sales in the first quarter of fiscal 2021. Net sales were favorably impacted by foreign currency translation of $5.5 million, primarily due to the strengthening of the Chinese renminbi relative to the U.S. dollar in fiscal 2022. Net sales were also favorably impacted by customer recoveries for spot buys of materials and premium freight costs of $22.1 million. Without the impact of foreign currency translation and customer cost recoveries, net sales increased $48.0 million, or 4.4%.
Cost of products sold
Cost of products sold increased $84.8 million, or 10.4%, to $898.7 million (77.2% of net sales) in fiscal 2022, compared to $813.9 million (74.8% of net sales) in fiscal 2021. The increase was primarily due to higher material, logistics and other operating costs of $88.3 million as a result of higher sales volumes and the impact of global supply chain disruptions and factory inefficiencies. Excluding foreign currency translation, cost of products sold increased $81.4 million. Labor costs were higher in fiscal 2022 as fiscal 2021 included the impact of temporary salary reductions and four-day work weeks in response to the COVID-19 pandemic. This was partially offset by lower restructuring costs of $3.5 million. Restructuring costs included within cost of products sold were $1.3 million in fiscal 2022, compared to $4.8 million in fiscal 2021. Material costs were also impacted by product sales mix.
Gross profit margin
Gross profit margin was 22.8% of net sales in fiscal 2022, compared to 25.2% of net sales in fiscal 2021. The decrease was due to higher material, logistics and other operating costs associated with global supply chain disruptions and factory inefficiencies, higher labor costs and product mix, partially offset by higher sales volumes.
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Selling and administrative expenses
Selling and administrative expenses increased $7.2 million, or 5.7%, to $134.1 million (11.5% of net sales) in fiscal 2022, compared to $126.9 million (11.7% of net sales) in fiscal 2021. The increase was primarily due to higher stock-based compensation expense, salary expense and travel expense, partially offset by lower restructuring costs and professional fees.
Stock-based compensation expense increased $5.0 million as our long-term incentive plan was not introduced until the second quarter of fiscal 2021. Salary and travel expense was lower in fiscal 2021 as a result of actions we took in response to the COVID-19 pandemic which included temporary salary reductions and four-day work weeks (which ended in the second quarter of fiscal 2021) and the elimination of most business travel. Restructuring costs included within selling and administrative expenses were $2.3 million in fiscal 2022, compared to $3.4 million in fiscal 2021. Professional fees decreased $1.8 million mainly due to lower Hetronic-related legal fees.
Amortization of intangibles
Amortization of intangibles decreased $0.2 million, or 1.0%, to $19.1 million in fiscal 2022, compared to $19.3 million in fiscal 2021.
Interest expense, net
Interest expense, net was $3.5 million in fiscal 2022, compared to $5.2 million in fiscal 2021. The decrease was primarily due to lower average borrowings. Average borrowings were higher in fiscal 2021 due to the precautionary $100.0 million draw-down under our revolving credit facility in March 2020, which was fully repaid in the third quarter of fiscal 2021.
Other income, net
Other income, net decreased $1.9 million to $10.3 million in fiscal 2022, compared to $12.2 million in fiscal 2021. Net foreign exchange losses were $1.9 million in fiscal 2022, compared to $0.3 million in fiscal 2021. In fiscal 2022, we received $10.0 million of government assistance at certain of our international locations with respect to the COVID-19 pandemic, compared to $11.1 million in fiscal 2021. In addition, we received an international government grant of $1.1 million in fiscal 2022.
Income tax expense
Income tax expense increased $3.7 million, or 29.4%, to $16.3 million in fiscal 2022, compared to $12.6 million in fiscal 2021. Our effective tax rate increased to 13.8% in fiscal 2022, compared to 9.3% in fiscal 2021. In fiscal 2022, the effective income tax rate was favorably impacted by the amount of income earned in foreign jurisdictions with lower tax rates, the release of a valuation allowance of approximately $2.0 million due to a tax law change, and less U.S. tax on foreign income of $1.7 million attributable to lower earnings in non-U.S. jurisdictions, partially offset with non-deductible compensation of $2.1 million. In fiscal 2021, the effective income tax rate was favorably impacted by the amount of income earned in foreign jurisdictions with lower tax rates, tax credits and various deductions allowed in foreign jurisdictions. In addition, the Company received a benefit of approximately $7.2 million related to a favorable tax ruling in a foreign jurisdiction.
Net income
Net income decreased $20.1 million, or 16.4%, to $102.2 million in fiscal 2022, compared to $122.3 million in fiscal 2021. The impact of foreign currency translation increased net income by $1.1 million. Excluding foreign currency translation, net income decreased $21.2 million as a result of the reasons described above.
Operating Segments
Automotive
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 30, 2022 | May 1, 2021 | ||||||
| Net sales | ||||||||
| North America | $ | 400.9 | $ | 406.4 | ||||
| EMEA | $ | 216.5 | $ | 212.3 | ||||
| Asia | $ | 164.1 | $ | 137.0 | ||||
| Net sales | $ | 781.5 | $ | 755.7 | ||||
| Gross profit | $ | 150.0 | $ | 163.4 | ||||
| As a percent of net sales | 19.2 | % | 21.6 | % | ||||
| Income from operations | $ | 92.6 | $ | 107.6 | ||||
| As a percent of net sales | 11.8 | % | 14.2 | % |
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Net sales
Automotive segment net sales increased $25.8 million, or 3.4%, to $781.5 million in fiscal 2022, compared to $755.7 million in fiscal 2021. Sales volumes in fiscal 2021 were negatively impacted from the COVID-19 pandemic. Fiscal 2022 net sales benefitted from customer recoveries from spot buys of materials and premium freight costs of $13.2 million (primarily in North America). Excluding foreign currency translation and customer cost recoveries, net sales increased $9.4 million, or 1.2%.
Net sales in North America decreased $5.5 million, or 1.4%, to $400.9 million in fiscal 2022, compared to $406.4 million in fiscal 2021. The decrease was primarily due to lower lighting product sales volumes. Net sales in EMEA increased $4.2 million, or 2.0%, to $216.5 million in fiscal 2022, compared to $212.3 million in fiscal 2021. The weaker euro, relative to the U.S. dollar, decreased net sales in EMEA by $4.5 million. Excluding the impact of foreign currency translation, net sales in EMEA increased $8.7 million primarily due to higher sensor product sales. Net sales in Asia increased $27.1 million, or 19.8%, to $164.1 million in fiscal 2022, compared to $137.0 million in fiscal 2021. The stronger Chinese renminbi, relative to the U.S. dollar, increased net sales in Asia by $7.6 million. Excluding the impact of foreign currency translation, net sales in Asia increased $19.5 million primarily due to higher electric vehicle product sales volumes, partially offset by lower touchscreen sales volumes.
Gross profit
Automotive segment gross profit decreased $13.4 million, or 8.2%, to $150.0 million in fiscal 2022, compared to $163.4 million in fiscal 2021. Excluding the impact of foreign currency translation, gross profit decreased $14.3 million. Gross profit margins decreased to 19.2% in fiscal 2022, from 21.6% in fiscal 2021. The decrease in gross profit margins was primarily due to higher material and other costs associated with supply chain disruptions and product mix, partially offset by higher sales volumes and lower restructuring costs. In fiscal 2022, we recognized $0.1 million of restructuring costs in this segment, compared to $4.8 million in fiscal 2021.
Income from operations
Automotive segment income from operations decreased $15.0 million, or 13.9%, to $92.6 million in fiscal 2022, compared to $107.6 million in fiscal 2021. Excluding the impact of foreign currency translation, income from operations decreased $16.2 million. The decrease was primarily due to lower gross profit and higher selling and administrative expenses. Selling and administrative expenses increased due to higher salary expense, partially offset by lower restructuring costs. Salary expense was lower in fiscal 2021 due to the impact of salary reductions and other cost saving measures in response to the COVID-19 pandemic. Restructuring costs in this segment's selling and administrative expenses were $0.1 million in fiscal 2022, compared to $1.4 million in fiscal 2021.
Industrial
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 30, 2022 | May 1, 2021 | ||||||
| Net sales | $ | 318.1 | $ | 267.9 | ||||
| Gross profit | $ | 101.5 | $ | 98.1 | ||||
| As a percent of net sales | 31.9 | % | 36.6 | % | ||||
| Income from operations | $ | 67.1 | $ | 64.3 | ||||
| As a percent of net sales | 21.1 | % | 24.0 | % |
Net sales
Industrial segment net sales increased $50.2 million, or 18.7%, to $318.1 million in fiscal 2022, compared to $267.9 million in fiscal 2021. Fiscal 2022 net sales included $7.6 million of customer cost recoveries of premium freight costs. Excluding the impact of foreign currency translation and customer cost recoveries, net sales increased $40.3 million, or 15.0%, due to higher sales volumes of all product categories in the Industrial segment. Sales volumes in fiscal 2021 were negatively impacted by the COVID-19 pandemic.
Gross profit
Industrial segment gross profit increased $3.4 million, or 3.5%, to $101.5 million in fiscal 2022, compared to $98.1 million in fiscal 2021. Excluding the impact of foreign currency translation, gross profit increased $2.3 million. Gross profit margin decreased to 31.9% in fiscal 2022, from 36.6% in fiscal 2021. The decrease in gross profit margins was due to lower gross profit margins from busbar products and commercial vehicle products and the recognition of $1.2 million of restructuring costs in this segment in fiscal 2022.
Income from operations
Industrial segment income from operations increased $2.8 million, or 4.4%, to $67.1 million in fiscal 2022, compared to $64.3 million in fiscal 2021. Excluding the impact of foreign currency translation, income from operations increased $2.0 million. The increase was primarily due to higher gross profit, partially offset by higher selling and administrative costs. Selling and administrative expenses were higher primarily due to $2.2 million of restructuring costs in this segment in fiscal 2022, compared to $1.0 million in fiscal 2021.
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Interface
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 30, 2022 | May 1, 2021 | ||||||
| Net sales | $ | 59.8 | $ | 61.6 | ||||
| Gross profit | $ | 12.6 | $ | 12.3 | ||||
| As a percent of net sales | 21.1 | % | 20.0 | % | ||||
| Income from operations | $ | 9.9 | $ | 8.9 | ||||
| As a percent of net sales | 16.6 | % | 14.4 | % |
Net sales
Interface segment net sales decreased $1.8 million, or 2.9%, to $59.8 million in fiscal 2022, compared to $61.6 million in fiscal 2021. Fiscal 2022 net sales benefitted from customer recoveries from spot buys of materials and premium freight costs of $1.3 million. Excluding customer cost recoveries, net sales decreased $3.1 million, or 5.0%. The decrease was primarily due to lower sales volumes of appliance products which were negatively impacted by a shortage of semiconductor chips, partially offset by higher sales volumes of legacy data solutions products.
Gross profit
Interface segment gross profit increased $0.3 million, or 2.4%, to $12.6 million in fiscal 2022, compared to $12.3 million in fiscal 2021. Gross profit margin increased to 21.1% in fiscal 2022, from 20.0% in fiscal 2021. The increase was due to higher sales volumes of legacy data solutions products.
Income from operations
Interface segment income from operations increased $1.0 million, or 11.2%, to $9.9 million in fiscal 2022, compared to $8.9 million in fiscal 2021. The increase was primarily due to higher gross profit and lower selling and administrative expenses. Selling and administrative expenses were lower due to restructuring costs of $0.7 million recognized in this segment in fiscal 2021.
Medical
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 30, 2022 | May 1, 2021 | ||||||
| Net sales | $ | 4.2 | $ | 2.8 | ||||
| Gross profit | $ | (0.4 | ) | $ | (0.3 | ) | ||
| Loss from operations | $ | (5.5 | ) | $ | (4.6 | ) |
Net sales
Medical segment net sales increased $1.4 million, or 50.0%, to $4.2 million in fiscal 2022, compared to $2.8 million in fiscal 2021. The increase was due to higher product demand.
Gross profit
Medical segment gross profit was a loss of $0.4 million in fiscal 2022, compared to a loss of $0.3 million in fiscal 2021. Gross profit was impacted by higher material costs and unfavorable sales mix, which offset the increase in net sales.
Loss from operations
Medical segment loss from operations increased $0.9 million, or 19.6%, to $5.5 million in fiscal 2022, compared to $4.6 million in fiscal 2021. The increase in the loss was due to higher selling and administrative expenses, primarily higher advertising expenses and professional fees.
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 unsecured 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 the COVID-19 pandemic and other geopolitical risks, including the Russia-Ukraine war and the lockdowns in China, our liquidity position could be severely impacted.
At April 30, 2022, we had $172.0 million of cash and cash equivalents, of which $107.0 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.
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Share Buyback Program
On March 31, 2021, the Board of Directors authorized the purchase of up to $100.0 million of our common stock. Such 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 30, 2022, a total of 1,593,139 shares have been purchased at a total cost of $71.2 million since the commencement of the share buyback program. As of April 30, 2022, the dollar value of shares that remained available to be purchased under this share buyback program was approximately $28.8 million.
On June 16, 2022, the Board of Directors authorized an increase in our existing share buyback program under which we may purchase up to an additional $100.0 million of our outstanding common stock, and also extended the expiration from March 31, 2023 to June 14, 2024.
Credit Agreement
Our senior unsecured credit agreement provides for a $200.0 million revolving credit facility and a $250.0 million term loan. As of April 30, 2022, no principal was outstanding under the revolving credit facility and we have $199.9 million of availability under the revolving credit facility. As of April 30, 2022, $206.3 million in principal was outstanding under the term loan. The term loan matures in September 2023 and requires quarterly principal payments of $3.1 million over the five-year term, with the remaining balance due upon maturity. We were in compliance with all covenants under the Credit Agreement as of April 30, 2022. For further information, see Note 10, “Debt” to the consolidated financial statements included in this Annual Report.
On December 10, 2021, we entered into a First Amendment to the Credit Agreement (“First Amendment”). The First Amendment amended and restated the Credit Agreement to provide, among other things, that upon the occurrence of certain events, the interest rate calculation method will generally transition from the London Interbank Offered Rate (“LIBOR”) to an alternate reference rate, including the Secured Overnight Financing Rate (“SOFR”) for U.S. dollar denominated borrowings. The consequences of the discontinuance of LIBOR cannot be entirely predicted but could result in an increase in our cost of borrowing.
Our senior unsecured credit agreement provides an option to increase the size of our revolving credit facility and term loan by an additional $200.0 million, subject to customary conditions and approval of the lenders providing the new commitments. There can be no assurance that lenders will approve additional commitments under current circumstances. We may seek to raise additional capital and our access to, and cost of, financing will depend on, among other things, global economic conditions, conditions in the global financing markets, the availability of sufficient amounts of financing, and our future prospects.
Cash Flows
| Fiscal Year Ended | ||||||||
|---|---|---|---|---|---|---|---|---|
| (in millions) | April 30, 2022 | May 1, 2021 | ||||||
| Operating activities: | ||||||||
| Net income | $ | 102.2 | $ | 122.3 | ||||
| Non-cash items | 66.4 | 50.7 | ||||||
| Changes in operating assets and liabilities | (69.8 | ) | 6.8 | |||||
| Net cash provided by operating activities | 98.8 | 179.8 | ||||||
| Net cash used in investing activities | (37.4 | ) | (24.8 | ) | ||||
| Net cash used in financing activities | (114.6 | ) | (142.9 | ) | ||||
| Effect of foreign currency exchange rate changes on cash and cash equivalents | (8.0 | ) | 3.8 | |||||
| (Decrease) increase in cash and cash equivalents | (61.2 | ) | 15.9 | |||||
| Cash and cash equivalents at beginning of the period | 233.2 | 217.3 | ||||||
| Cash and cash equivalents at end of the period | $ | 172.0 | $ | 233.2 |
Operating activities
Net cash provided by operating activities decreased $81.0 million to $98.8 million in fiscal 2022, compared to $179.8 million in fiscal 2021. The decrease was due to higher cash outflows related to changes in operating assets and liabilities. The $69.8 million of cash outflows for operating assets and liabilities in fiscal 2022 was primarily due to higher inventory (as a result of global supply chain and logistics disruptions) and lower accounts payable and other liabilities.
Investing activities
Net cash used in investing activities was $37.4 million in fiscal 2022, compared to $24.8 million in fiscal 2021. The activity primarily represents capital expenditures in both fiscal years. We received $0.6 million of cash from the sale of property, plant and equipment in fiscal 2022.
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Financing activities
Net cash used in financing activities was $114.6 million in fiscal 2022, compared to $142.9 million in fiscal 2021. In fiscal 2022, we used $64.5 million of cash for the purchase of shares under our share buyback program, compared to $6.7 million in fiscal 2021. We paid cash dividends of $20.4 million in fiscal 2022, compared to $17.4 million in fiscal 2021. We increased our quarterly dividend from $0.11 per share to $0.14 per share in the first quarter of fiscal 2022. In fiscal 2022, we paid $0.3 million in taxes related to the net share settlement of equity awards compared to $3.9 million in fiscal 2021. In fiscal 2022, we had net repayments on our borrowings of $29.2 million. In fiscal 2021, we had net repayments on our borrowings of $115.2 million, which included the repayment of the $100.0 million precautionary draw-down on our revolving credit facility from March 2020.
Contractual Obligations
The following table summarizes our significant contractual obligations and commercial commitments as of April 30, 2022:
| Payments Due By Period | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||
| Finance leases | $ | 0.8 | $ | 0.4 | $ | 0.3 | $ | 0.1 | $ | — | |||||||||
| Operating leases | 24.0 | 6.5 | 7.3 | 3.2 | 7.0 | ||||||||||||||
| Debt (1) | 211.4 | 13.0 | 197.1 | 0.4 | 0.9 | ||||||||||||||
| Estimated interest on debt (2) | 5.6 | 3.7 | 1.7 | 0.1 | 0.1 | ||||||||||||||
| Deferred compensation | 8.0 | 1.6 | 1.9 | 1.8 | 2.7 | ||||||||||||||
| Total | $ | 249.8 | $ | 25.2 | $ | 208.3 | $ | 5.6 | $ | 10.7 |
(1)
Assumes the outstanding borrowings under the revolving credit facility will be repaid upon maturity of the credit agreement in September 2023.
(2)
Based on interest rates in effect as of April 30, 2022 (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.
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 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 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 currently are preparing 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. Hetronic has opposed that petition. The Supreme Court has requested the views of the Solicitor General on the petition for certiorari. Like any judgment, particularly any judgment involving defendants outside of the United States, there is no guarantee that we will be able to collect all or any portion of the judgment.
We incurred legal fees of $3.3 million, $5.7 million and $5.4 million in fiscal 2022, fiscal 2021 and fiscal 2020, respectively, related to the lawsuits. These amounts are included in the selling and administrative expenses and as part of the Industrial segment.
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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 and notes. 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. Below are the estimates that we believe are critical to the understanding of our results of operations and financial condition. Other accounting policies are described in Note 1, “Description of Business and Summary of Significant Accounting Policies” to the consolidated financial statements included in this Annual Report.
The full impact of the COVID-19 pandemic is unknown and cannot be reasonably estimated for these key estimates and assumptions. However, we made appropriate accounting estimates based on the facts and circumstances available as of the reporting date.
Revenue recognition. Most of our revenue is recognized at a point in time. We have determined that the most definitive demonstration that control has transferred to a customer is physical shipment or delivery, depending on the contractual shipping terms, except for consignment transactions. Consignment transactions are arrangements where we transfer products to a customer location but retain ownership and control of such product until it is used by the customer. Revenue for consignment arrangements is recognized upon the customer’s usage.
Revenue associated with products which we believe have no alternative use, and where we have an enforceable right to payment, are recognized on an over time basis. Revenue is recognized based on progress to date, which is typically even over the production process through transfer of control to the customer.
In addition, from time to time, customers may negotiate annual price downs. Management has evaluated these price downs and determined that in some instances, these price downs give rise to a material right. In instances that a material right exists, a portion of the transaction price is allocated to the material right and recognized over the life of the contract.
Allowance for excess and obsolete inventory. Inventories are valued at the lower of cost or net realizable value and have been reduced by allowances for excess and obsolete inventories. The estimated allowances are based on our review of inventories on hand compared to estimated future usage and sales, using assumptions about future product life cycles, product demand and market conditions. If actual product life cycles, product demand and market conditions are less favorable than those projected by us, inventory write-downs may be required.
Goodwill. Goodwill is not amortized but is tested for impairment on at least an annual basis. Goodwill is evaluated at the reporting unit level by comparing the fair value of the reporting unit to its carrying amount including goodwill. An impairment of goodwill exists if the carrying amount of the reporting unit exceeds its fair value. The impairment loss is the amount by which the carrying amount exceeds the reporting unit’s fair value, limited to the total amount of goodwill allocated to that reporting unit. In performing the goodwill impairment test, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount.
Qualitative factors include, but are not limited to, the results of prior year fair value calculations, the movement of our share price and 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. If, after assessing the qualitative factors, we were to determine that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then a quantitative assessment is performed. We may also elect to proceed directly to the quantitative assessment without considering such qualitative factors.
For the quantitative assessment, we utilize either, 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 appropriate valuation multiples observed for the reporting unit’s guideline public companies. The determination of discounted cash flows is based on our long-range forecasts and requires assumptions related to revenue and operating income growth, asset-related expenditures, working capital levels, and other market participant assumptions. The revenue growth rates included in the forecasts are our best estimates based on current and anticipated market conditions, and the profitability assumptions are projected based on current and anticipated cost structures. Long-range forecasting involves uncertainty which increases with each successive period. Key assumptions, such as revenue growth rates and profitability, especially in the outer years, involve a greater degree of uncertainty.
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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. If impairment indicators exist, we perform an impairment analysis by comparing the undiscounted cash flows resulting from the use of the asset group to the carrying amount. If the carrying amount exceeds the undiscounted cash flows, an impairment loss is recognized based on the excess of the asset’s carrying amount over its fair value.
Income taxes. Our income tax expense and deferred tax assets and liabilities reflect management’s best assessment of estimated current and future taxes to be paid. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated income tax provision and in evaluating income tax uncertainties.
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 report tax-related interest and penalties as a component of income tax expense.
Our deferred tax assets and liabilities reflect temporary differences between the amount of assets and liabilities for financial and tax reporting purposes. We adjust these amounts to reflect changes in tax rates expected to be in effect when the temporary differences reverse. 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. The realization of tax benefits is evaluated by jurisdiction and the realizability of these assets can vary based on the character of the tax attribute and the carryforward periods specific to each jurisdiction. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would decrease income tax expense in the period a determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be recorded to income tax expense in the period such determination was made.
We provide for taxes that may be payable if undistributed earnings of overseas subsidiaries were to be remitted to the U.S., except for those earnings that we consider to be permanently reinvested. Future sales of foreign subsidiaries are not exempt from capital gains tax in the U.S. We have no plans to dispose of any of our foreign subsidiaries and are not recording deferred taxes on outside basis differences in foreign subsidiaries for the sale of a foreign subsidiary.
Contingencies. We are subject to various investigations, claims and legal and administrative proceedings covering a wide range of matters that arise in the ordinary course of business activities. A significant amount of judgment and use of estimates is required to quantify our ultimate exposure in these matters. For those matters that we can estimate a range of loss, we have established reserves at levels within that range to provide for the most likely scenario based upon available information. The valuation of reserves for contingencies is reviewed on a quarterly basis to ensure that we are properly reserved. Reserve balances are adjusted to account for changes in circumstances for ongoing issues and the establishment of additional reserves for emerging issues. While we believe that the current level of reserves is adequate, changes in the future could impact these determinations.
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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