Modine Manufacturing Co (MOD) 2004 Q2 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Modine second quarter financial results conference call. On the call today are David Rayburn, President and Chief Executive Officer, and Brad Richardson, Vice President of Finance and Chief Financial Officer.

At this time, I would like to inform you that all participants in are in a listen-only mode. At the request of the company, we will open up the conference for questions and answers after the presentation. Before we get started, I would like to read Modine's Safe Harbor statement. This conference call may contain forward-looking statements that involve assumptions, risks, and uncertainties, and Modine's actual results, performance, or achievements may differ materially from those expressed or implied in these statements.

A detailed discussion of factors that could affect Modine's results are on page 25 of the company's fiscal 2003 annual report to shareholders, and in recent public filings with the U.S. Securities and Exchange Commission. Modine does not assume any obligation to update any of these forward-looking statements.

I will now turn the conference over to Mr. Dave Rayburn, Modine's President and CEO. Mr. Rayburn?

Good morning. Excuse me my cold, so I may struggle a little bit here. Unfortunately, a number of people in the Midwest are struggling also with the Cubs loss. But we will deal with that thing this morning at a later time.

Good morning and thanks for your participation in Modine's second quarter conference for fiscal 2004. Modine reported its second quarter and first half fiscal '04 results yesterday. And I would like to take an opportunity to go over some of the highlights that were in our earnings release, which is available on our website under Investor Relations section.

For the second quarter, and the first half, this is the fifth consecutive quarter with year over year sales increase. We also continued to benefit from net favorable currency exchange rates. Our balance sheet continues to be very strong and give us plenty of flexibility.

Near-term, our -- we're near completion on our third phase of our investments in Europe. We're very excited about this, because this is one of the reasons why we're gaining some incremental business long-term. And that three phases are our new headquarters, our tech center, and, to be completed in the spring, our new wind tunnel.

Results are highly in line with our expectations. Anticipated in the second quarter results, we are impacted by program launches, which is not unusual for some new technology that we were developing for the second half. And those costs were typically in the area of development cost, engineering cost, test costs and manufacturing. We also, unfortunately, had a strike at one of our major customers in Europe. One of their suppliers had a strike. And that disrupted BMW's production of the Series III.

But the second quarter is not reflective of what we feel our full year will look like. We are on target for growth in both sales and earnings for the full year on the full year basis. Recently launched programs and number of new programs that are scheduled to ramp up in the second half will lead to that stronger performance that we've talked about.

Something we can talk about, we have announced that the BMW -X 3 program, which is starting off very well and it is a nice looking vehicle if you haven't seen it, a new program that it is launching right now in North America for the Chrysler group. And several new engine programs, both in North America and Europe, and the EGR program we launched a number of years ago will be ramping up for significant volume in Europe for Volkswagen.

I should note though the second half could be impacted by economic changes or continued issues in the geopolitical side, and certainly we have to execute it, because as you bring up new business you have to execute, especially when you're dealing with new technology. I would like to now turn the call over to Brad Richardson, Modine's Chief Financial Officer. Brad?

Thank you, Dave. And good morning to everyone. Before I get started with my prepared remarks, I would like to make you aware that we plan to issue an amended second quarter earnings release later this morning.

The amendment is to correct a math error. I don't know if you saw that as you looked at our press release, but if you look at "Total Liabilities" on the balance sheet, the reported -- the total liability amount did not include the current liabilities; therefore, in short, we had a summation error as it related to calculation of our total liability. So we will be issuing an amended return again later this morning. For the second quarter, sales increased over 1% to $279.1 million from $275.3 million reported a year ago.

For the first six months of the fiscal year, sales showed an increase of 4%, increasing from $547.6 million a year ago to $568 million this year. Net earnings for the second quarter were 13 cents per fully diluted share compared with 19 cents for the same period a year ago.

Turning to year to date results, as a reminder, we recorded a $21.7 million goodwill impairment charge in the aftermarket business in the first quarter of fiscal 2003, resulting in a loss of $5 million or 15 cents per fully diluted share for the first half of last year. Earnings before the impact of the goodwill impairment charge were $16.7 million, or 49 cents per fully diluted share. This compared to earnings this year of $15.6 million or 46 cents per fully diluted share.

Net favorable currency exchange rates, primarily the Euro, added about $34.9 million to first half sales, and approximately $3.6 million to pretax earnings. In addition to currency, ongoing pricing pressures and some significant events impacted our first half results, including acceleration of retirement benefit-related expenses, which were $1.9 million on a pretax basis, and a certain program scope change cost of $1.6 million.

The program scope change charge is related to investment, tooling, and inventory costs incurred in support of a specific North American OE program which has not been scaled back significantly. I would note that we don't believe that the result of the scale back program will have a material impact on the $320 million net new OE programs previously announced, As there are other program gains that offset this scope change.

As Dave previously discussed, we do not believe our second quarter results are indicative of our full-year outlook. We expect that recently-launched programs and a number of new programs that will be ramping up later this year, will generate positive second half sales and earnings growth. I would now like to give you some segment results for the second quarter.

Once again, sales from the European automotive and heavy-duty markets recorded a year over year increase. Total sales for the European operation segment rose from more than 3% -- rose more than 3% to $82.3 million from $79.7 million a year ago. While the week and a half long supplier strike at BMW that Dave discussed earlier in this call had a negative impact on this segment's sales and operating income, the stronger Euro had a positive effect.

Other contributing factors to the rise in operating income, which increased from $5.8 million in the second quarter of last year to $6.3 million this year, included lower SG&A costs, as well as savings from the restructuring in the European heavy-duty business.

Sales in the North American original equipment segment decreased almost 4% to $110.9 million from $115.1 million a year ago. Sales in the automotive business were down slightly from last year. Our medium duty and heavy duty business had lower sales in the second quarter, although sales are up on a year to date basis.

Operating income for this segment decreased from $18.7 million in the previous year to $13.3 million this year, having been negatively impacted by continuing pricing pressure, new program launch costs that Dave spoke to, and the program scope change costs mentioned earlier. Our off-highway and industrial business continued to benefit from its customer and product rationalization strategy, generating improved profitability and operating performance on lower sales during the first half of the year.

For the distributive products segment, sales increased approximately 1% to $96.9 million, from $95.8 million a year ago, benefiting from the growth in the electronics business, while being negatively impacted by slightly lower sales in the aftermarket and H-vac business. Operating income rose from $2 million in the previous year to $2.8 million this year.

A product mix shift associated with the end market and sales for the electronics business had a negative impact on this segment's operating income, while performance improvement in the aftermarket had a positive impact. As we expected, capital expenditures for the first half of the year showed an increase to $34.7 million from last year's $17.7 million, reflecting the ongoing construction of the Vacers North Germany facility, as well as the new tech center and wind tunnel.

These new facilities will give us the capability and flexibility to support additional business programs. We are also near completion on our three-phase investment in Europe for the new European headquarter, tech center, and wind tunnel, the latter of which is scheduled to be commissioned in the Spring of next year. We believe that our European tech center and wind tunnel investments will generate incremental new business over and above what we have already announced in the years to come.

Turning to our balance sheet, which remains strong with very good liquidity, we ended the quarter with a cash balance of $71.8 million, an increase of $1.6 million versus the first quarter --despite higher capital outlays that we just discussed -- increased dividend payment, and continued scheduled debt reductions. While generating 48 million in operating cash flow on a year to date basis, we reduced our total debt to capital ratio to 16 -- to 16% from 17.3% at the end of the last fiscal year. I will now turn the call back to Dave.

Thanks, Brad. Now I would like to take a moment and discuss our fiscal '04 outlook. We would like to reaffirm our positive position on the full year. Program launch expenses incurred in the first half of the year are in support of growth that will be ramping up in the second half.

As a result, the strong second half will allow us to achieve sales and earnings growth on the full year. I would like to comment on the overall market conditions that we serve. We are seeing some strengthening in the North America, truck, specifically the class 8 market, and specifically for our fourth quarter; and next year, market size has been estimated between 210 and 240, which certainly would be good news.

We're also seeing some strengthening in our order boards with both our ag and construction customers in North America. Offsetting though, the market in Europe and automotive is down, and specifically, the BMW, which has had a great run on their Series III, it is starting to mature. As well as, we're seeing some softening in the ag and construction markets in Europe.

We are monitoring and managing some issues. It continues, obviously, significant price pressure, specifically in the automotive segment of our business. But we are aggressive in developing counter measures in regards to taking design costs out and working with our engineers and the customers' engineers in order to be able to not to deter performance of our products, but at the same time take costs out of the overall system.

Our aftermarket business continues to be a challenge, as we've discussed in the past. There is increasing competition, changing market conditions, changing -- changes and challenges in our distribution to channels, and restructuring activities that we've been taking to bring value to our bottom line. As Brad mentioned, we are seeing some short-term improvements and we continue to work on the tactical side of reducing our costs, both source costs and our manufacturing costs.

An example of that would be the recent announced consolidation of our manufacturing of radiators into our Emporia Kansas facility, which had historically made copper brass facilities, and we are going to be consolidating all of our aluminum radiator manufacturing in that facility as well. Electronics market continues to be a challenge. As you're aware, the fundamentals have changed in that industry.

There has been more focus on the consumer market as a result of the continued down volume in the high-end segment of that business. But we continue to work, again, as we are in the aftermarket on the break even of that business, and being very tactical at the same time, ensuring that we do not impair this business for the long term growth that we see because of the fundamentals being very real on the needs for better solutions, technical solutions, thermal solutions in this market.

At the same time, we are focused on continuing operating improvement, generating additional growth for new and next generation products. and from our capital investments,

Key short-term is execution of the new programs that we are launching that I've discussed. And continuing to develop positive returns for our shareholders as we secure and launch the new business that we've discussed, the $320 million of new business for our original equipment programs that will be maturing over the next five years. That concludes our formal statements for the quarter. We will now entertain some questions.

Thank you, sir. The question and answer session will be begin at this time. If are you using a speaker phone, please pick up the hand set before pressing any numbers. Should you have a question, please press star one on your push button telephone.

If you wish to withdraw that question, please press star two. Your questions will be taken in the order that they are received. Please stand by for your first question, gentlemen. Our first question comes from David Seno of Gabelli and Company. Please state your question.

Hi, good morning. The operating income in the OE segment went from -- was down about $5 million year over year. Was that all launch costs?

Good morning, David. It is Brad. Good to talk with you this morning.

It is clearly the launch costs, also this program scope change that I referred to, the charge that we took, that is in the operating income for the OE segment;and then clearly, as Dave mentioned, the ongoing pricing pressures that we have in the North American OE segment also were in there. Those three items.

But as these new programs, significant new business comes on, it is safe to say that you will have launch costs in coming quarters similar to this quarter?

No, Dave, this is Dave. Certainly the significant amount of the launch costs for these new programs were incurred in the first half. Being realistic, we realized that programs have to ramp up.

We are not really saying that we are incurring launch costs in business that has been very traditional for us. For example, the X 3, the Northern Chrysler program I mentioned. Where we seek launch costs is where we're bringing some new technology out, where we're launching new equipment, new process, and the product validation process, is pretty extensive. And most of that is behind us.

Okay. And then the scope change that you mentioned, this has no effect on the $320 in revenue?

Yeah, I think, Dave we're comfortable, as I put in my prepared remarks, that clearly there is an -- a negative associated with the scope change, but since with we provided that $320 estimate last quarter, there has been additional secured business. So therefore, we feel comfortable in the $320 that we released last quarter.

Sure. And my last question, I guess this is the lowest operating margin you've had in original equipment in some time. I think you have to go back three or four years, even if you adjust for the scope change. Can you just comment on -- in general, how -- if your productivity improvements are keeping pace with the price -- price-downs you're experiencing, or is that a negative on the margin that might not come back?

Well, certainly, Dave, there are multiple inputs to the gross margin; and the new business starting that we've mentioned that is in this segment will certainly give us an absorption impact, so that will certainly have a very positive impact on gross margin.

In regards to the pricing side, it is very real. It is the way you have to do business. But we are being very proactive in that side. And productivity on the plant floors -- candidly, we have applied and continue to apply lean manufacturing, and a number of the contemporary methods in our factories; but oftentimes, that is really offsetting the economics that we have in those businesses.

Where our opportunity is, candidly, in the dealing with the price erosion that's taking place, is in the design side. And fortunately, the customers that we deal with are more of a partnering relationship versus the old traditional gun to your head, and in that partner relationship, they -- many of them make engineering resources available, as we do, to work on design cost reductions.

So as I mentioned in my -- in our earlier comments; the real opportunity is to take value out of the system, cost out of the system, versus out of our shareholders' pockets; and fortunately, we have a number a number of customers that are very proactive in that side, so it allows them to be competitive in our marketplace as we reduce our prices, and at the same time ensuring that their supply base is going to be available long term. But I will say it is a challenge. And certainly North America and what Chrysler has gone through has created some challenges for all of us.

David, if I could just add to that.

Again, in the quarter, as Dave had mentioned, clearly there was the program scope change, there was the launch expense for a new product versus a traditional product, and therefore, we don't believe that there has been a set function change in our operating margins. We don't believe that the second quarter is indicative of any kind of sep function change in our operating margins.

I would imagine, Dave, you will be back and confirming that at the end of the third quarter conference.

Okay. Thanks, guys.

Gentlemen, our next question comes from Adam Hurwitz of Sedoni and Company, please state your question, sir.

Good morning.

Good morning, Adam.

My first question was, could I get a little more handle on exactly how much the strike at BMW impacted results?

Yeah, I think, Adam, we're -- we don't generally disclose things like that, but you know, it is roughly in the kind of the million dollar type range.

Okay. Thank you.

And the dynamics in Europe versus North America, because of the contractual relationships with our employees, you don't have the flexibility that you have in North America when you have a program interruption like we've had with BMW.

Okay. On the "Other Income" line, there seemed to be a pretty big jump versus the year-ago quarter. Could you give me a little more color on what was happening there?

Sure, Adam. What is going on there is, clearly in the last year's second quarter, we recorded a $1.7 million charge for the sale of our Canadian business. Clearly, we don't have that impact in this -- this year's quarter.

So we have the absence of the charge last year, plus we have higher royalty income on, clearly, licenses that we have when we get royalties on those. Those are the two significant factors affecting that year over year variance.

What was the factor -- why were royalty costs higher? Was it a function of -- patents?

It is royalty income, not costs.

Okay.

And simply again, I mean we have an ongoing program, clearly, to monetize, if you will, the investments that we've made and the patents that we have, and that's -- you're seeing the results of that.

Okay. Last question here, when you spoke about the aftermarket -- or I don't know if you spoke about it but in the press release -- sales were down, but you mentioned something about an improvement in the aftermarket. What were you referring to exactly here?

You know what -- clearly, in the aftermarket -- as you know, that has been a very, very competitive business -- we have been very focused, as Dave said, on kind of tactical issues, of focusing in on our costs, and our costs of taking product to market, and so I think I would like to leave it at that, that there has been very, very strong focus on our costs, in order to drive kind of near-term improvement in that business.

Okay. Fair enough. Okay. That's all I have for you today. Thank you.

Thanks, Adam.

Adam, thank you.

Our next question comes from David Fondry of Heartland Funds, please state your question, sir.

Yes, good morning. A lot of these are follow-ups to earlier questions, but I kind of missed the numbers that you gave, I think you said there was a cost of accelerated retirement benefits, I think you put a number on that?

The cost -- I actually don't think I did, but what it is, is about $1.6 million of -- was your question on retirement or was your question on the program redefinition?

Well, I'm going to get to program redefinition, too.

The retirement is $1.9 million and the program redefinition is about $1.6.

$1.6. And when you talk about a program redefinition or change in scope, does that -- does that suggest that the manufacturers cut back their estimates of sales for a particular vehicle and therefore, you -- if you had two molds you might go down to one mold or something like that?

No, we -- let me clarify that. The program, in regards to the designs that we were bringing forward and the application, is still active. As far as the number of platforms that the program is now being applied to has been reduced, and as a result of that, you have tools and, candidly, some inventory that is not needed to support the reduced number of platforms that the technology is being applied to.

And what were the reasons that they are no longer applying those to those platforms -- or to the expanded platforms?

That's really detail that I would rather not get into. It is confidential, candidly, for the customer, and I don't want to divulge our customers' strategies.

Okay. I think that's fair enough. The scope changes, do those costs show up in cost of goods? 1.9 -- the I guess the $1.6 million, is it flow-through cost of sales or is it partially in SG&A?

Majority of it is in cost of goods sold.

And would that also be true of the accelerated retirement benefits?

No, the accelerated retirement benefits is in SG&A.

And that was -- that would explain, I guess, why SG&A is up sequentially? Okay.

Yeah. I think I would also note, David, that clearly, the exchange rate, which clearly has had a net positive impact, when you translate SG&A dollars from Europe, due to the strength of the Euro, they translate into more U.S. dollars. So that's probably the other factor you should be thinking about.

Okay. And then going back to other net, can you give us just in broad generalities the composition, I know you said royalties, what percentage of that $4.3 million is royalties versus other miscellaneous income? If you can, to the extent that -- to the extent that you can provide us clarification there.

Yeah, I mean what I would just like to leave at this point, I mean the royalties probably make up about 25% of the total number; but that's, again, what's driving -- that, and the absence on the loss of Canada, is what is driving the change.

Well, sequentially, it was up a million dollars. Give or take. $900,000. Other Q1.

Yup, and that is a function of royalty income.

Okay. And is that sustainable going forward in your view?

You know, I think is it going to plateau out at that level? I wouldn't project on that. Some of our royalties are in industries that come in large lumps. To where they apply it in -- in the power plant area, and where they're taking our technology and applying it into very large applications that we traditionally wouldn't manufacture for, but our technology is applicable; and some of this comes in large chunks, and that's really what you're seeing here.

Okay. So as they complete a major project of some sort and you get a one-time royalty thing until they -- two years later, they do another one or something like that.

Exactly. And that was part of this second quarter incremental. And we would expect that to continue. But it is not as smooth as you would see in some of our more traditional areas for our pay and PF technology or automotive applications, where that's typically fairly flat on a quarterly basis.

Gotcha; and then lasty, you mentioned that the electronic business was still somewhat weak and you weren't seeing much improvement, but as I listen to conference calls, and projections for the remainder of the year and going into 2004, hearing a fair amount of positive things coming out of telecom -- in particular, some 3 G build-outs over in Europe. Are you seeing any improvement in the electronic segment at all?

Let me comment. We really serve multiple portions of the electronics market. And short-term, we have been focusing more on what we call consumer, or the computer side. And we've had to actually -- some incremental volume that has started and some others that will be starting in the second half, which is encouraging for us because we have a break-even issue.

I also listen to those -- those news reports in regards to some new optimism in that whole electronics market. Where we're seeing some incremental volume right now is on the low end. In servers and the like, that really are using more traditional solutions.

And in the high-end, for telecommunication, some of the high end servers and the telecommunication market, there is still an awful lot of capacity out there that has not been applied, and that piece where we will have real strength, we've not really seen any volume increase. I think on a tactical basis, we're seeing more application discussions with those customers, but it won't be real to me until we see it in the order board. So we still want them to stay very focused at this business.

We think that technology long-term in regards to -- as power goes up, speed goes up, heat goes up, and thermal solutions will be -- have to be more robust, so the fundamentals of the acquisition are real, but the technology drivers are pretty flat right now. And it is more -- we're seeing the market activities on the low end where more of the traditional solutions are used. But I am -- I am looking for those -- that same opportunity, and I keep challenging our organization to make sure that as it recovers, that we get our fair share.

Great. Thank you very much. Appreciate it.

Thank you.

Thank you. If there are any further questions at this point, please press start one on your push button telephone at this time. Once again if you have any further question, please press star one on your push button telephone. If there are no further questions, I will now turn the conference back to Mr. Rayburn to conclude.

Well, I appreciate your participation today. I always enjoy getting some feedback on their investment community on their reflections on Modine, and we look forward to talking to you at the end of next quarter. Thank you very much.

Thank you sir. Ladies and gentlemen, this conclude our our conference call for today. Thank you for participating and have a great day. All participants may now disconnect.