Modine Manufacturing Co (MOD) 2004 Q3 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Modine third-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'd like to inform you that all participants 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 United States Securities and Exchange Commission. Modine does not assume any obligation to update any of these forward-looking statements. I will now turn the conference call over to Mr. Dave Rayburn, Modine's President and CEO. Mr. Rayburn.

Good morning and welcome from a very cold Racine, Wisconsin, and thank you for participating in Modine's third-quarter conference call for fiscal 2004.

Modine reported its third-quarter financial results yesterday. First I would like to go over some of the highlights in the earnings release which were available to you on our website under investor relations. At our last conference call we indicated our second-quarter was not reflective of our full year outlook, specifically driven by a supplier strike at BMW in the second quarter, and launch costs associated with the new technology and initial phase of new business.

We also said recent launch programs and additional new business that would be ramping up in the latter half of the year would generate positive second half sales and earnings growth. Well, in the second (technical difficulty) third quarter, as we had started to deliver that stronger second half that we projected; double-digit increase in both sales and earnings compared with the third quarter of last year, sales for the quarter was a record for the year. It's the sixth quarter in a row of year-over-year sales increase, but obviously we've been helped by favorable currency exchange. Positive contribution from new business that we talked about in ramping up and continued operational improvements as we drive these results. All of this has generated strong operating cash flow and further reduction of our debt.

Recently we announced that the launch of the new 2004 Dodge Durango program with the Chrysler Group, and very excitedly opened our new Agristar (ph) facility in Germany, currently supplying engine cooling modules for the new BMW X-3 Sports Utility, the current 3-Series, the recently launched Z4 sports car, and next year we'll be supplying out of this facility BMW's new 1-Series and the new 3-Series that will be launching in the latter half of the year.

This is just one example of our positive relationships that we build with our customer base. We'll also be announcing shortly other new programs that we are launching currently. I would now like to turn over the call to Brad Richardson, Modine's Chief Financial Officer. Brad.

Thank you, Dave, and good morning to everyone, and I agree, it is a cold morning in Racine. Let me have some prepared remarks here. For the third quarter, sales increased over 14 percent to 310.8 million from 271.8 million reported a year ago. As Dave mentioned, this is a record for Modine. For the first nine months of the fiscal year, sales showed an increase of 7 percent from 819.4 million reported a year ago to 878.8 million this year. Net earnings for the third-quarter were 12.3 million or 36 cents per fully diluted share, an increase of 28 percent compared with the 9.6 million or 29 cents per fully diluted share for the year ago comparable period.

Turning to year-to-date results, earnings before the cumulative effect of accounting change for the first nine months showed an improvement of over 6 percent to 27.9 million or 82 cents per fully diluted share compared with 26.3 million or 78 cents per fully diluted share reported a year ago. 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 net earnings of 4.6 million or 14 cents per fully diluted share for the first nine months of last year.

As Dave mentioned, we continued to benefit from net favorable currency exchange rates, primarily the euro, which added 17.5 million to sales and 1.9 million to pretax earnings in the third quarter. In addition to currency, there are several other significant events that impacted our third-quarter results.

As you can see, the other income line showed an increase over the last year. Higher royalty income among other factors contributed to the increase. We had a recognition of about 700,000 in royalty income that was in arrears in the third quarter. We incurred expenses of 2.2 million as a result of an agreement reached with an European Original Equipment customer associated with a product performance issue which impacted our gross profit. We also have $1 million in warranty costs relating to a North American Original Equipment customer also impacting our gross profit.

I would now like to give you some segment performance data for the third quarter. Sales in the North American Original Equipment segment increased over 12 percent to 127.5 million from 113.6 million a year ago. The three business units in the segment, the North American automotive, truck, and the off-highway and industrial businesses all recorded an increase in sales. Despite continued pricing pressure, costs incurred that Dave mentioned in launching new programs and products, and the warranty expenses I just discussed, we were able to increase this segment's operating income by almost 8 percent to 19.8 million from 18.4 million a year ago.

Excluding the $1 million in warranty costs previously mentioned, operating margins for the segment increased to 16.3 percent from 16.2 percent reported last year. We achieved this profit -- improved profitability on the strength of new business programs such as the recently announced 2004 Dodge Durango program for the Chrysler Group and a number of engine related programs.

For the Distributed Products segment, sales increased 5 percent to 87.5 million from 83.3 million a year ago, benefiting from higher revenues in both the HVAC and electronics businesses while the aftermarket business had essentially flat sales. Operating income turned from a loss of $900,000 in the previous year to a profit of 900,000 this year. Strong product sales and savings from restructuring in the HVAC business, as well as continued effort to reduce costs in the aftermarket business, all contributed to this segment's improved profitability.

The electronics business had the largest percentage increase in sales among the segment business unit. However, lower margins associated with a shift in product mix continued to have a negative impact on this segment's operating income.

Total sales for the European Operations segment rose 19 percent to 106.9 million from $90 million a year ago. The stronger euro, as well as new and accelerated business programs, contributed to this increase. While net favorable currency exchange rates had a positive impact on this segment's profitability, this impact was more than offset by the 2.2 million expenses related to the product performance issue previously discussed. As a result, operating income for this segment stayed flat at 12.1 million compared with 12.3 million in the third-quarter of last year. Excluding the $2.2 million charge, the operating margin would have been 13.4 percent compared with 13.7 percent of last year.

In the third quarter, we continued to make improvements to maintain a strong balance sheet and excellent liquidity. Despite continued debt reductions and higher capital expenditures, which showed an increase on a year-to-date basis to 51.7 million from last year's 26.3 million, we ended the quarter with a cash balance of 83.4 million, an increase of 11.6 million, and 6.2 million respectively over the 71.8 million at the end of the second quarter and 77.2 million at the end of the fiscal 2003.

We were able to increase our cash balance on the strength of our strong operating cash flow in the quarter which increased to 38.9 million from 20.4 million a year ago. The strong operating cash flow has allowed us to further reduce debt, including $8.2 million debt reduction in the quarter, bringing the total debt to capital ratio to 15.3 percent from 17.3 percent at the prior year end. I will now turn it back to Dave.

Thanks, Brad. Our stronger third-quarter results are consistent with our expectations. To continue this positive trend we will continue to focus on the execution of this new business that we've talked about, maintaining our focus on operational improvements and excellence, benchmarking our best practices, proactively managing business issues such as pricing that we're seeing in all of our segments, particularly the automotive business, as well as challenges in our aftermarket and electronics businesses. Continued effort in our customer and product diversification is also a priority on a global basis. And I must say, globalization is not only an external priority, it's an internal priority as we work on our systems, generating additional growth from our capital expenditures.

As Brad mentioned, our capital expenditures increased this year. This is a short-term increase and is a result of our commitment to the state-of-the-art facility such as our new tech center in Europe and, to be launched this spring, our new wind tunnel which is very exciting and will build incremental growth. For the rest of the fiscal year we expect continued positive contribution for the new business, fixed cost absorption, and better utilization of our facilities. The fourth quarter will produce another similar year-over-year performance for our shareholders as we saw in the third quarter. We are on target to achieve the growth in sales and earnings on a full year basis for the second consecutive year. That concludes our prepared comments. We'd be glad to take any questions from our guests.

(OPERATOR INSTRUCTIONS) David Siino of Gabelli & Co.

Good morning, Dave and Brad. Brad, one question. Looking at the onetime items, if you want to call them that, keeping currency in there because that's just going to ebb and flow. It looks like if you take the 2.2 plus the 1 less the .7, maybe the EPS would look 5 cents higher, and I guess kind of an ongoing basis the number would be 41 cents, is that the right way to look at it?

Good morning, by the way. I think that's appropriate. Again, you can choose whether or not you want to assume the currency as a permanent item or an item that we would adjust for to calculate the underlying performance.

Right. Okay. Second question, I guess if you could update us on your thinking in regards to M&A. You've indicated that you've recently strengthened that area of your business. With the dividend being where it is, and your feelings about stock buyback, and you're still generating a significant amount of cash even in a heavy CAPEX year, what's the vision? Where do we go from here?

Dave, we've commented in the past that we've put a much stronger priority in that area than maybe we have in the past. And you do that by putting resources on it and management's attention. And I must say, we've been doing that. We've been spending a lot of time evaluating opportunities, searching out their experienced markets, understanding where potential opportunities are. It's interesting, Dave, as you increase the activity, you go down a lot of blind holes, and I think that's what we're trying to do to make sure that we're being responsible in regards to the opportunity we have to expand our business on a global basis. We've got to make sure that they're the right decisions other than the emotional decision.

Specifically, I think we continue to look within our traditional markets. Those traditional markets, I would say, are primarily North America and Europe. Those opportunities are limited, candidly, because of a lot of the consolidation that's taken place in the past, but we'll continue to look at that and have. I think the global issue probably is the area that probably is, one, the Company has needs to have a much larger global print than we have today, although we've made great progress. And also, we need to continue to evaluate, and are evaluating, new segments. Certainly our move into electronics business, although I still support that move, but certainly the timing wasn't the greatest in the world. But, that's not going to deter us from continuing to evaluate outside our traditional box. So, really three initiatives there.

David, I can also just add to that. Dave said that we clearly have screened a lot of things and we go down a lot of -- I think you used the term blind alleys, which is absolutely true. And you go down those alleys because you find out that businesses that we look at don't make the strategic fit that Dave was articulating. We also go down those alleys when we find out that the opportunity will not be accretive to the returns and margins of the business. So I just want to leave with you that there is a very disciplined approach that we are using to ensure that, if we do acquire, that we can demonstrate that it will be accretive to our return on capital as well as our margins as a percent of sales.

Can you just give us a range of kind of the size of businesses you're looking at?

You know, I think, David, we're certainly looking at businesses. You won't see us looking at megabusinesses in the kind of $200 million range, but clearly if you look at our balance sheet, you know we have the capacity to look at acquisitions in the $50 to $100 million type range.

Okay, great. Nice quarter.

Laura Thoreaux (ph) of Robert W. Baird.

Good morning. It's cold up here in Milwaukee too.

Schools are out I understand because of the cold whether.

A couple, yes. I just had a question on the royalty income in arrears. I guess, could you give a little more color on that or explain how that happens that you have that in arrears?

Yes, Laura, good morning. Let me just respond. A couple things here. One is, we've talked a lot about the investment that the Company continues to make in R&D and the patents that we continue to pursue. And this royalty income stream is one of the benefits of that investment. And specifically, we will license in areas that we don't currently manufacture. And in the quarter, we have a license with a company that actually manufacturers heat transfer products for the power plant business which, as you know, is not a market that we play in. But again, we have technology that supports that business.

We had a company that had not been current in terms of paying us royalties, and so we elected -- obviously because of their status -- not to book the full amount until they became current. And in the quarter, because of some agreements that we reached with that company, they are now current and we recognized the incremental income as a result of that agreement.

Okay. Great. And then on the other income line, I know you mentioned a couple of items that were in there, royalty income being one of them. Is the rest of that pretty big jump year-over-year currency?

There is some currency in there. The other thing that I would point out that's in there is this is where we have equity earnings in our joint ventures. As you know, we have a joint venture in France, we have a joint venture in Brazil, and we have a joint venture in Japan. And our Brazilian joint venture actually showed strong performance versus the prior year quarter. That was up over $500,000. So that's part of the increase that you see in the other income due to the performance of the Brazilian joint venture.

Let me just add, Laura, there in regards to our JV, Radiadores Visconde, which we're a 50 percent equity holder in in Brazil. We entered that business -- we had a need because a number of our customers were either there or going to Brazil, and we have found that just an excellent partner down there. And that business was primarily focused on the aftermarket, both internally as well as export. And we've been on a journal with them in regards to increasing their capabilities in getting into new technology such as vacuum bracing and aluminum cab raising (ph). And I'm really pleased the way that management team down there is growing their OE share with customers like Volkswagen and Caterpillar and others.

While they continue to be successful in their aftermarket activities, which is certainly different than we're enjoying here, we're pleased that it allows us to have that global footprint expanded. And to maybe embellish what we talked with David about, is what we're pursuing in the future is not just acquisitions, but also finding the right partners that know how to operate in a particular economic environment where maybe folks from Racine might bump around in the dark with. So, hopefully we're going to be able to find the right kind of partners on a global basis and certainly Radiadores would be an example of our success that I'd like to repeat in other regions.

Great. That's all I have. Thank you.

(OPERATOR INSTRUCTIONS) Andrew Wiener of Bernstein.

Good morning. Could you -- recognizing that your other income line is fairly lumpy from quarter-to-quarter because of royalty payments and other items that you account for on that line, can you give us sort of a rough ballpark of what we should think of as a normal quarterly run rate?

Hope Brad doesn't ask me to answer that.

I'll just turn that over to Dave, Andrew. I think, if you look at that line item, where we've been on a year-to-date basis, again, I wouldn't expect -- that, on a year-to-date basis, has contributed almost 13 million to earnings. I wouldn't expect it to the running at that high of a rate and there has been some catch-up if you will. I think I would probably just like to leave it at that. I'm not in a position really to forecast exactly what that balance is going to do. Again, the royalty income made it lumpy this time, as you pointed out. And then there is some transaction gains from foreign currency that also makes that lumpy.

Just to embellished, the PF traditional royalties that we've enjoyed over the years, those are starting to play out in regards to time and some decisions that have been made in various locations. But we're going to continue to have what I'd call project royalties where, as Brad talked about, the specific with this one company that applied our technology in the power industry, I think there's some future opportunity for us to leverage our technology into other markets and create further royalty streams, and we're going to be working on that in the future.

The other income line, as you can tell, is a material part of your income and I'm just trying to get, without pinning you to a specific number and projection, I'm just trying to get a sense for how I should think about the growth opportunities in that line over the next year or two, i.e., either royalties or other ventures where you have pretty good visibility on their ability to be recognized. So, it sounds like the 5 million plus that you hit this quarter is maybe a little bit above because of the catch-up from those past royalties that you already described. But, it also sounds like you have some growth, so maybe the 2 million from last year, is that a little bit too low? Should I think about maybe a $2 to $3 million run rate?

$2 to $3 million per quarter?

Yes.

Which I think -- the upper band of that may be a bit on the high side, but I think -- I wouldn't build into that line item significant growth.

Got it. Thank you for your help.

Sure. Absolutely.

Dennis Ganelle (ph) of Rutabaga Capital.

Hi, Dave and Brad.

You've got some cold weather in Boston, haven't you?

Ah, but it's a balmy day today. Schools are open thank goodness. Just a quick question on the electronics business. Can you size a little bit of the increase that you saw quarter-over-quarter. Was this maybe just some inventory fill at the distributor level, or is there something more sustainable you guys are seeing?

Let me ramble a little bit on that because it certainly has taken a lot of my attention and our management's because the overall business performance has been certainly disappointing because of what the market has gone through. We've seen growth in -- I would call it a mix change -- but we've seen nice growth in the consumer side where we provide heat pipes into -- for laptop computers and some product into desktops, and that's coming out of our relatively new facility we have in Taiwan. So, we're seeing some nice volume increase there.

We're also seeing some modest increase in Europe in our UK operation, although relatively low. But what's encouraging, but I'm not ready to put it in my forecast, is that we're starting to hear increased activity from telecommunications. Certainly there's been a lot of public hype about telecommunication responding, but candidly what we see them is burning off inventory, and because of the cost pressures in that marketplace, of maybe reverting back to some of the older technologies like extrusions.

But we're starting to see some project activity, and when you see project activity eventually you see volume, and so we don't expect the boom in telecommunication we saw before, but I'm anticipating hopefully that next year we're going to see some growth in that segment. And that's the traditional segment that that business was in. Our ventures into the consumer side in the computer side is relatively new for that business because it had always been very commodity oriented in extrusions, but because of downsizing and performance and those kinds of products, we've been able to get some nice gain.

But we continue to work hard on this business in rightsizing it, we continue to have some real challenges in North America volume that we're continually evaluating our alternatives on rightsizing that business. At the same time we absolutely have to make sure that we're doing the right things technically and getting on the product roadmaps with folks like IBM and Intel and Apple, etc. So, we'll see long-term when this market turns, but in the short-term we're focusing on consumer market and some of our technology developments.

So when you talk about the mix, it's a heavier consumer mix that is kind of depressing margins there?

Yes, and there is a mix issue there that's current. So we're seeing some increased volume but lower profitability on those lines.

And if we do see an increase on kind of the higher end of the electronic spectrum, the telecom equipment, network equipment and so on, is your capacity in the right place to deliver those more sophisticated thermal products? I'm thinking that so much of the capacity for the electronics industry seems to have migrated towards Asia out of Europe and North America. Can you do more than just heat pipes out of Taiwan?

We're providing some product called -- some modular assemblies that are really a power type of product for a desktop application out of there, so it's not just heat pipes. We do have low cost, and cost is king, in all of these markets because of what they've done. We've got a very low-cost facility in Mexico that gives us lots of flexibility to deal with some of the cost pressures. We do have -- there's a rather sizable position and telecommunication in Europe that I think we're well-positioned there to support.

But long-term, we need to be on mainland China, in mainland, and whether we do that via a partner or a greenfield, we're continuing to evaluate our alternatives. But a large part of our customer base in that marketplace is over there, and we can serve them short-term out of Taiwan -- and out of Mexico candidly. But we need to have a presence over there. So that's something that we'll be working on.

Great. And just one last thing on that. I kind of remember that business when you acquired it being -- I don't know -- 50, 60 plus million in revenues. Can you kind of size where you guys are now or is that kind of your current run rate?

About 40 percent.

Okay. Ouch.

And the nice thing is that if that business was still on its own it would be gone. Part of the size of company we are today -- I may be a little low on that, maybe more like 55 percent.

Dennis, this business is high $30 million a year type business.

They finished about 59 (multiple speakers) with acquisitions. So that's the challenge that we have is we can put up with, candidly, some deterioration in our overall profitability if we truly believe a long-term play is right, and we do. But that continues to be a challenge for management.

Sure. Great. Thanks a lot.

(OPERATOR INSTRUCTIONS) If there are no further questions I will now turn the conference back to Mr. Rayburn to conclude.

I appreciate everybody's attendance this morning and your questions. We are going to be sending a survey out to those that participated, ask for some feedback in both content and response. And we appreciate if you'd work with John Ge on getting that back so we can make this as constructive for you as we can. I look forward to talking with you after our year-end, and hopefully we'll deliver (technical difficulty) talked about. Have a great day.

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