Modine Manufacturing's CEO Discusses F3Q 2014 Results - Earnings Call Transcript

Jan.31.14 | About: Modine Manufacturing (MOD)

Modine Manufacturing Company (NYSE:MOD)

F3Q 2014 Earnings Conference Call

January 31, 2014 9:00 AM ET

Executives

Kathleen T. Powers – Vice President, Treasurer and Investor Relations

Thomas A. Burke – President and Chief Executive Officer

Michael B. Lucareli – Vice President, Finance, and Chief Financial Officer

Analysts

Michael D. Shlisky – JPMorgan Securities LLC

David Leiker – Robert W. Baird & Co. Equity Capital Markets

Walter S. Liptak – Global Hunter Securities LLC

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal 2014 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to turn the call over to Kathleen Powers, Vice President, Treasurer and Investor Relations. You may begin.

Kathleen T. Powers

Thank you for joining us today for Modine’s third quarter fiscal 2014 earnings call. With me today are Modine’s President and CEO, Tom Burke; and Mick Lucareli, our Vice President of Finance and Chief Financial Officer.

We will be using slides for today’s presentation. Those links are available through both the webcast link as well as a PDF file posted on the Investor Relations section of our company website modine.com. Also, should you need to exit the call prior to its conclusion a replay will be available through our website beginning approximately two hours after the call concludes.

On slide two is an outline for today’s call. Tom and Mick will provide comments on our third quarter results and update our revenue and earnings guidance for fiscal 2014. At the end of the call, there will be a question-and-answer session.

On slide three is our notice regarding forward-looking statements. I want to remind you that this call may contain forward-looking statements as outlined in today’s earnings release as well as in our company’s filings with the Securities and Exchange Commission.

With that, it is my pleasure to turn the call over to Tom Burke.

Thomas A. Burke

Thank you, Kathy, and good morning, everyone. I am pleased to report for the third consecutive quarter that Modine has reported year-over-year growth of revenue, earnings and cash flow.

We delivered adjusted earnings per share for the quarter of $0.16, up 14% from the prior year and our revenues were up 6% primarily driven by sales increases in Europe and Asia along with strong North American heating product sales in our commercial product segment.

Excluding the impact from lost sales due to the Airedale fire in the UK, sales would have been up nearly 9%. We provide updates on our end markets for the calendar year 2014 on this call. Looking forward we will provide our initial outlook for 2015 fiscal year during our yearend earnings call in late May.

Turning to page six. Revenue was up 1% in North America with higher sales to commercial vehicle and automotive customers, offsetting the decrease in sales to off- highway customers. In North America off-highway segment continues to be pressured by the weak demand particularly for agricultural and mining equipment.

Construction markets appear to be stabilizing and in some cases show signs of improvement. Automotive and light-duty orders remain steady and we are pursuing additional opportunities in this area, (inaudible) standards continue to drive the need for additional engine and power trucking, heat transfer technology.

Looking forward we expect mixed market conditions in North America to continue during calendar 2014. We expect heavy truck production to be flat to up 5%, medium truck production to be up 3% to 8%, and the overall off-highway markets to be flat to down 5% versus the prior year. We anticipate in particular that the agriculture equipment segment of the off-highway market will remain a challenge in calendar 2014.

Please turn to page seven. Our Europe segment sales increased 21% in the third quarter, driven by higher sales to commercial vehicle customers, higher tooling sales and the impact of the stronger euro. Excluding the impact of currency, sales grew 16%. The increase in sales to commercial vehicle customer is primarily driven by higher launch volumes for components for Euro 6 vehicles.

In addition about one quarter of the increase related to existing Euro 5 programs. As we have mentioned over the last – past two quarters it was clearly a pre-buy of Euro 5 vehicles favorably impacted our revenues this year. As we have dual effect of higher sales on mature Euro 5 programs while also seeing volume increases as Euro 6 program ramped production.

As a result of the pre-buy, we expect commercial vehicle volumes in Europe to decrease by 3% to 8% in calendar 2014. Sales to automotive customers in Europe relatively flat as higher sales of automotive components were offset by a decrease of automotive modules, as the BMW program continues to wind down. The revenue of the BMW wind down during the quarter was about $5 million. We continue to expect the broad European auto sector to be flat to up 5% in calendar 2014. And we expect continue to see smaller declines in sales of BMW modules as a remaining programs continue to wind down.

As I mentioned in last quarter, our focus in Europe is on reducing manufacturing inefficiencies in our new commercial vehicle programs and on reaching a final stages of our restructuring program. We continue to improve our overall process capability in our new Euro 6 truck radiator production, which is critical as our program volumes increase.

We took significant restructuring in impairment charges during the quarter, primarily related to our decision to combine two manufacturing facilities in Germany. This consolidation will complete our restructuring plan for the region. We expect this consolidation to take about 18 months, with the initial production equipment transfers starting at February.

Moving to South America on page eight. Excluding currency impacts, sales were down 5% due primarily to lower sales to commercial vehicle, automotive and power generation customers. Sales to aftermarket customers were down slightly from the prior year. Earlier in the year, South American markets had seen sales increase in the range of 20% that slowed considerably toward the end of calendar 2013.

As a result some of our key customers took an extended Christmas holiday to work down excess inventory. We expect this to be temporary and the production will increase in our fourth quarter.

In addition, last year in Brazil helps to support our European restructuring efforts by temporarily producing product, as our Europe team move production of certain components between plants. And this also contributed to the year-over-year sales decline.

Our outlook for calendar 2014 for this segment as for market conditions in Brazil to remain challenge, resulting a flat to 5% growth in commercial vehicle and aftermarket sales and a flat agriculture equipment market.

Please turn to page nine. Our Asia segments sales increased by 30% with increased export sales from India to European automotive customers and increased domestic sales of off-highway customers in China.

India commercial vehicle and off-highway markets continue to show weakness, but I am encouraged by the growth in the export market. Export sales to be a big driver for sales growth in India particularly given the current weakness of the Indian rupee.

In China, the construction market, which is very important for our Asian operation is improving and we are seeing the impact on our build schedules. We have also been awarded some additional oil cooler business that will be slip between Europe and Asia, improving the volumes of the stainless steel oil coolers produced in our Shanghai plant.

The outlook for our markets in Asia is for generally flat to low growth in all sectors. We are actively evaluating growth and diversification strategies in this region and are fully committed to reaching a volume above or breakeven point.

Turing to page 10. Sales in our Building HVAC business were down 10% in the quarter. This was driven by $7.4 million decrease in sales from our Airedale business in UK resulting from the fire that halted production at the Airedale manufacturing facility at September 6th. This was partially offset by an increase in sales of North American heating products. Prior to the fire our Airedale business was having a great year, as I mentioned in last quarter they maintained the vast majority of the orders despite the resulting delays.

In the mean time, a few of the customer are canceled the orders due to the delayed delivery schedule, who have actually come to Airedale and are willing to wait for their product. We are up and running in our temporary facilities and are taking orders and delivering product. Although our lead times are currently as longer than we would like, our orders were nearly to the level we saw before the fire. We are approximately 70% capacity and are adding additional shift production.

We just about concluded the due diligence process associated with the Barkell acquisition, we still believe will be in the position to close this transaction before the end of our fiscal year.

In North America our heating product sales up 17% in the quarter clearly ahead of market growth. The recent cold weather has benefited this market and we have gained share due to our strong distribution system, superior product and lead times.

And with that, I’d like to turn over to Mick for an overview of our financial performance, and guidance.

Michael B. Lucareli

Thanks, Tom. Good morning, everyone. Please turn to slide 12, and I’ll review the income statement. As Tom mentioned, we had another strong quarter with a 6% rise in sales. I’m pleased to report that the gross margin increased by 160 basis points to 16.4%. Four of our five business segments delivered higher gross margins. The most significant drivers were the highest sales volume combined with favorable raw material costs.

SG&A was up 5% or $2 million year-over-year, we had declined 20 basis points as a percentage of sales. As noted in the last quarter, we are accruing for higher incentive compensation expenses, which is up $4 million year-over-year, beyond that SG&A spending is down.

Please note that during the quarter we have recorded the $11.4 million in restructuring related items to support the final phase of our European restructuring. As Tom explained the decision was made during the quarter to combine two manufacturing facilities in Germany into one manufacturing facility.

The largest piece is $9.4 million related to the employee severance costs. And then there is an additional asset impairment charge of $2 million related to this program. There is an appendix in this presentation along with more details in our public filings regarding the restructuring costs and the adjusted earnings calculations.

I would like to point out that the tax expense with lower as foreign tax law changes lower to the cash related [ph] liability. This resulted in a positive impact of about $2.5 million or $0.05 per share. So, on a GAAP loss per share for the quarter was $0.08 and our adjusted EPS was $0.16. This represents a significant improvement over the $0.02 last year.

Turning to slide 13. For the first nine months free cash flow was $51 million. There is a $43 million improvement over the same period a year ago. Free cash flow in the quarter was $23 million. This is a significant improvement over the $2 million created [ph] last year. And our target for full year capital spending is lowered slightly from last quarter to approximately $55 million, excluding replacement of Airedale assets.

The strong cash flow is continuing the strength in our balance sheet. Our net debt has declined by approximately $58 million during the year. Net debt to capital is 22% and our cash is increased to just over $86 million. Note that approximately $10 million of our cash balance relates to insurance proceeds from fire in the UK.

Please to turn to slide 14. And the left side of the slide has a summary of our North American segment. As Tom mentioned, first quarter sales were relatively flat. Despite the top-line challenge, the gross margin improved 200 basis points to 15.5%. The improvement was primarily due to favorable material costs and the performance related material savings.

Similar to last quarter, SG&A increase primarily due to the higher incentive compensation expenses and lower recovery of developing costs. Adjusting for these two items, the underlying rate of spending would be roughly flat. Overall operating income for the segment increase $0.5 million over the prior year.

Now looking at our European business segment on the right side, of the five segments Europe clearly at the strongest quarter with sales up 16% from the prior year on a constant currency basis. The gross margin improved 180 basis points to 12.2% year-over-year due to higher sales volume and favorable material costs.

As Tom mentioned, we have a lot more works to do with regards reducing manufacturing inefficiencies with our new commercial vehicle programs and completing our restructuring.

SG&A increased $800,000 versus prior year due to higher incentive-based compensation expenses. However, as a percentage of sales, SG&A improved 90 basis points due to the highest sales volume and the result of restructuring actions previously taken.

We have included restructuring related items on the slide to compare the underlying operating results. Excluding new restructuring related costs, operating income increased $4.3 million to $6.1 million.

Moving on to slide 15. We have summary of our South American and Asia business segments. The foreign exchange rate had a negative impact in Brazil during the quarter, on a constant currency basis sales in South America were down slightly 5% or $2 million. This was the result of several unrelated items as mentioned by Tom.

The gross margin declined 120 basis points to 16.3% on the lower sales volume. Overall the lower sales volume in the quarter resulted in $1.5 million year-over-year decline in operating income.

Now turning to the right side at our Asia business segment. Sales in the quarter increased $4 million or 30%. Approximately $1 million of the increase is related to tooling sales. The remaining growth is tied to ongoing program launches in the region. As discussed in previous quarters, this segment’s margins and earnings are highly depended on sales volume.

You can see how the gross margin improved significantly due to higher sales volume along with ongoing favorable material cost and manufacturing improvements. While the result show an operating loss of $600,000, we are moving towards that breakeven point and this represents the $1.9 million improvement year-over-year.

On slide 16, at the Building HVAC business segment. Reported sales were down $4 million or 10%, but as Tom mentioned this decline is due to the fact that the fire at our Airedale facility. The impact in the sales from the fire during this quarter was approximately $7 million. Excluding that impact, the segment sales were actually up more than 7%.

Our gross margin increased due to favorable product mix. Sales of our relatively higher margin heating products increased due to the extreme weather conditions and market share gains. SG&A decreased $600,000 from prior year, partly due to the smallest scale of our Airedale operations in UK and we have not recorded income for insurance proceeds related to the recovery of lost profits.

We have submitted our first business interruption claim for loss profit, but we don’t know yet when we will receive the first payment. Overall this was a very solid quarter for the HVAC segment.

Now let’s turn to our remaining fiscal 2014 guidance on slide 17. As a result of another strong quarter we are increasing our fully year guidance. Our revenue growth has been nearer to the range of 5% to 8% over the prior year. We anticipate adjusted EPS be in the range of $0.65 to $0.70 versus the previous range of $0.50 to $0.60.

We continue to estimate SG&A will be in the $180 million range based on the current run rate. And even though we had a tax benefit this quarter, we continue to see the full tax year expense in the $12 million to $13 million range this implies a higher tax expense clearly in Q4.

We are pleased with the result along with earnings in cash conversion in this very difficult environment, but we are trying to remain cautious. In Europe, we are watching the commercial vehicle market closely and we are doing the same in South America.

We have one more quarter to go before we can close out a very solid year and we are in the middle of our fiscal 2015 planning process. Once both of those were compete, we will back to give you more perspective on the new fiscal year.

With that Tom, I’ll turn it back to you.

Thomas A. Burke

Thanks, Mick. You can turn to page 18. I’m pleased with results for the third quarter particularly with our third consecutive quarter of free cash flow generation. Overall, most of our end markets continue to hold steady and we anticipate flat-to-moderate growth for the foreseeable future.

Our European team continues to improve the manufacturing process this is impacting margin on our truck program launches in the region. And we will be focused on the consolidation of our German manufacturing footprint, which will be the final phase of our restructuring program.

Our Airedale business is up and running at our temporary facilities and continues to fill the order request despite the longer lead times. As Mick mentioned, it is great to see the business converting the increase in sales at such a strong rate.

Given the current strength for balance sheet in our position to evaluate options for growth and we are doing just that. We hope to close on Barkell acquisition in the fourth quarter and we report other initiatives as they evolve.

And with that, we’ll take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from line of Mike Shlisky of JPMorgan. Your line is open.

Michael D. Shlisky – JPMorgan Securities LLC

Good morning. Hello.

Thomas A. Burke

Hi Mike.

Michael B. Lucareli

Hey Mike.

Michael D. Shlisky – JPMorgan Securities LLC

Hey just want to kick it off quickly with the EPS number. Looking at your release, is the $0.05 tax benefit included in the $0.16 or is that?

Michael B. Lucareli

In the guidance range we just gave the $0.65 to $0.70 that include the tax benefit that so our tax is in net number.

Michael D. Shlisky – JPMorgan Securities LLC

Okay, thanks. And then touching on China real quick, you had mentioned plans to really expand into the commercial vehicle business over there. You had some launches planned. How is that going for you so far and can you give us a little more color on the outlook as to how many more programs might be on the way there?

Thomas A. Burke

First half in China we are really pleased to see the market come back on the off-highway business, which is very important as we head [ph] down. In addition we have the oil cooler business is coming online and launching and is really strong in the next fiscal year that’s about $2.8 million oil coolers we will be launching over a period of time. This kind of really help to diversify that business.

In addition to your question we are really looking to diversifying the business and looking opportunities to push in to commercial truck business and so on. We obviously have landed some business already and we received cooler opportunities for more. So, all areas are aggressively pushing for growth, but clearly Asia has great opportunity and we are pushing that heavily.

Michael D. Shlisky – JPMorgan Securities LLC

Great. And then in South America, you had mentioned a production increase in the next quarter. Was that a year-over-year increase or was that sequential?

Thomas A. Burke

A sequential. That will be sequential increase obviously we saw tough third quarter for us, calendar fourth quarter for the reasons I mentioned on year-over-year basis. But we are starting to see as we came back from the standard shutdown, the strength of orders coming back in place both on the aftermarket side, our commercial vehicle customer we are talking about strengthening through the year coming out and in the calendar year. So, we anticipate that zero to 5% increase on the commercial vehicle side in growth.

Michael D. Shlisky – JPMorgan Securities LLC

Great. If I can just throw one last one in there on North America Ag. Could you maybe give us a little flavor as to how your orders looked in the quarter compared to the prior year or maybe how your backlog looks at this time of the year versus the same time last year?

Thomas A. Burke

Well, I think first we have described as we have had downtime or orders cut from our end customer. So, I mean that’s really a best way to describe it obviously a year ago at this time the Ag was running very strong so this was some of the first signs of market weakness we’ve seen in the past quarter. So, with commodity prices as they are anticipating the fact that probably going to continue a while we think it’s going to be a challenging year for Ag in North America.

Michael D. Shlisky – JPMorgan Securities LLC

Okay, great guys. Thank you so much.

Michael B. Lucareli

Yes thanks.

Operator

Thank you. Our next question comes from the line of David Leiker from Baird. Your line is open.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

Good Morning every one.

Thomas A. Burke

David, good morning.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

Couple of things, start with Europe here first off, your month into the first calendar quarter, any insight you can give us in terms of how much downtime your customers are taking as we go through this transition from Euro 5 to Euro 6?

Thomas A. Burke

What we’re seeing David right now is, we saw some extended downtime taking around the holidays, and the volume were actually reducing releases and pushing them out, we’re not saying they’re coming out, we are just pushing the orders out. So the ramp-up rate that was projected is the slope is decreasing, but we’re not taking the orders out so we’re kind of snow piling it forward. We have not seen a direct downtime although we’ve [spurred] speculation that there may be some down effect coming up but we have not seen any yet.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

And then are you in production, are you seeing your Euro 6 production volumes increase sequentially here or are you still -- I know there is still Euro 5 that is going to be going for export markets but what does that mix look like?

Thomas A. Burke

Yes so, well I think we said about – of the increase in commercial truck for the last quarter by quarter that was increased in Euro 5 because (inaudible), but we are seeing increases, the ramp-up is happening just not at the rate that we talked about. So Euro 6 volumes were coming we are just at a let’s say, a reduced level of [carrying and employing on Ford], but we are ramping up to a levels probably somewhere in the, something less than and then, may be 50% to 75% of our projected volumes we’re going to be at this time, the key points we’re are not pulling the orders but pushing them out.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

So we are not seeing a repeat of what we saw in Brazil?

Thomas A. Burke

Yes. That’s not yet.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

And then Scania talked about that they think it is the impact of this on the other side is going to impact calendar Q1 and calendar Q2 production. Are you seeing any of that?

Thomas A. Burke

Well it’s the snowfall effect to see if that’s keep going through the quarter right now, we’re pushing them into the next quarter from what we see in this quarter. So, we are assuming that some of that’s going to come true how much is going to be the question. So that is a pretty good indicator from that we’d have, we’re close to our customers and we’re clearly watching this because filling the pipeline for them is very important and so they are not taking their foot off the pedal at all. They’re just kind of saying we are just pushing them out.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

Okay, and then in Asia, it was a great progress and you can really see what you have done there on the cost side there. What do you think as incremental volume comes through here what the contribution margin is? I am guessing this year-over-year number we are seeing here is a little bit distorted but any sense as to what you can give us there, Mick?

Michael B. Lucareli

Yes I think we’ve been quite happy with this 25% type conversion on incremental volume David.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

And then just lastly in terms of consolidating the German plants, any detail, is this moving one plant into the other plant or putting up a new plant to replace the two or just what your thoughts are and what the strategy is?

Thomas A. Burke

This is consolidating two existing plants into one existing plant. So, this has been a long time in the making and as you know we have been working on this. I was able to give a lot of credit to European team and their partners in negotiating this, but it has been a very positive end result that we are very pretty pleased with. And it is going to take a while to get through 18 months, but it is starting right away.

And so it is going to be a -- again it is going to be delivered right on top of all the other things we’ve committed in that region. They’ve delivered both on SG&A reduction, asset reduction and consolidation of the tech center and this is the last peg we got to put in to the system here to tie down the restructuring. So, I’m very pleased with it.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

It has been a long journey and you have done great managing it. So it is good to see that come to an end.

Thomas A. Burke

The team has done a great job.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

What fiscal are you consolidating in to?

Thomas A. Burke

Well, I better not give specifics at this point, but it’s an existing facility in the German local network and again it’s a real good – it’s a good move overall as far as it gives us a little more flexibility of things we need to do because of the size of the facility and it’s a very good work force has been finished established here, so we are very pleased.

David Leiker – Robert W. Baird & Co. Equity Capital Markets

Okay great. Thank you very much.

Operator

(Operator Instructions). Our next question comes from the line of Walter Liptak of Global Hunter. Your line is open.

Walter S. Liptak – Global Hunter Securities LLC

Hi, thanks. Good morning.

Thomas A. Burke

Good morning Walt.

Walter S. Liptak – Global Hunter Securities LLC

Just to try the question on those two plants in Germany again and just thinking about the transition from Euro 5 to Euro 6. What kind of products are getting moved out of the facility that is closing and is the timing such that you don't get much disruption?

Thomas A. Burke

Any transfer of production is a critical transfer and it’s going to be in the aluminum product consolidation in which we have two aluminum plants that both doing what we call (inaudible) product both in off-highway and in automotive or consolidated [indiscernible] synergy because of that so that we are carefully, carefully designed this to make sure that there is no risk of interruption and that’s why 18 months projection of time we are getting it done at some port.

So, it will be by the end of this very much consolidated higher synergistic, but look with higher scale in the manufacturing or just manufacturing over that [ph].

Walter S. Liptak – Global Hunter Securities LLC

Okay, great. I will try one on the HVAC part of the business. The 17% heating increase looks really good. I wonder if you could talk about the weather impacts versus any new facilities that are going in, is this pent-up demand that was triggered by the extreme cold or how do you view this?

Thomas A. Burke

Well, the majority of our sales in the heating business is replacement business going into greenhouse and investor warehouses and the like of large let’s say [garage] facilities and that type of thing. So, by far there is going to be a replacement market till the weather is driving that. But I think this is kind of years into it again.

Our teams have come out and put leading product out there from an efficiency standpoint, reliability standpoint. And I think, I can’t give enough credit to our distribution network and manufacturing facilities are able to respond to the short-term orders. That’s a lot of time to have the replacement business. We go with the replacement they needed on-time with the large installed base and we have their works start to advantage. So, this is one of the times when we tipped the weather and it lined up well with pushing demand we are able to catch up.

Walter S. Liptak – Global Hunter Securities LLC

Okay. And this is, the demand is continuing into January?

Thomas A. Burke

Yes, we are seeing strong demand through January of this quarter and that’s a great for us because typically we will start stocking, okay for the stocking with the distributors in March and we are going to be pushing in to that pretty soon. We think it’s going to be ready in February from outlook. So, it’s going to great season.

Walter S. Liptak – Global Hunter Securities LLC

Okay great. Thank you.

Operator

(Operator Instructions). I’m not showing any further questions. I would like to turn the call back over to Kathleen Powers for closing remarks.

Kathleen T. Powers

Thank you. This concludes today’s call. Thank you for joining us this morning and thanks for your interest in Modine. Goodbye.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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