Modine Manufacturing Co (MOD) 2004 Q4 法說會逐字稿

Good morning and welcome ladies and gentlemen to the Modine 2004 fourth quarter and year end financial results conference call. On the call today are David Rayburn, President and Chief Executive Officer and Brad Richardson, Vice President, Finance and Chief Financial Officer. At this time, I would like to inform you that all participants are in a listen-only mode. At the request of the Company, we will open the conference up 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 assumption, risk 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 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 David Rayburn, Modine's President and CEO. Mr. Rayburn?

Thank you and good morning and welcome to our call. The press release and a PowerPoint presentation is located at our website and the PowerPoint presentation is focused on our proposed acquisitions.

First, I would like to thank those that participated in our investor survey that we sent out after our last quarterly call. And as a result of that, we are making some changes to our format today. We have provided in our release some additional information with the -- disclosing a consolidated cash flow statement, as well a condensed segment report. And hopefully, that allows your analysis to be more complete. Also, Brad and I, instead of just reading the press release that I hope most of you already have; instead, we're going to change the format and more talk to some of the highlights and provide some additional information. And we do have some other changes under consideration. So if you have further feedback on the content and format of this presentation, I would ask you to talk with John G. (ph) and we will consider any of those points.

First, I would like to highlight our fourth quarter performance. It is a continuation of the positive momentum that we established in the third quarter. We delivered the second half of the fiscal year as we projected. The robust year-over-year performance of both sales and earnings were very satisfying for us. Sales is another record for that quarter. It is the seventh consecutive quarter with year-over-year sales increase.

Highlight for the full year, for fiscal 2004 performance, is we had double-digit increase in both sales and earnings. The sales set a record for the Company at nearly 1.2 billion. The strong performance is a result of positive contribution from new business that we've launched this past year, in the second half specifically. The new BMW X3 program, the Dodge Durango program and various engine programs, both in North America and Europe with customers like International Volkswagen and others.

We have continued operational improvement. We've continued to work hard at the aftermarket issues and we've continued to consolidate some of those operations. We have expanded -- actually, we have a new plant and we're already expanding it in Taiwan for our electronics business and we're launching some new business for newer radiators for our off-highway business, aluminum radiators. And we continue to expand some of our Six Sigma activities both here and in Europe.

We certainly are enjoying the start of some recovery that we did see some increased volumes in the fourth quarter from the American truck, as well as the off-highway markets. We did have the benefit of favorable currency exchange rates. Our balance sheet, and Brad will be talking about our balance sheet in regards to its strength and giving us the flexibility to do the kind of things that we're hopefully going to do in Asia that we've just previously announced, and we continue to generate strong cash flows from operations.

Other announcements during the past quarter is we have announced new business with PSA, which is the Peugeot-Citroen organization in Europe with incremental sales of nearly $7-$8 million. We have won a long-term relationship with International for the next series of engines that will be coming out in '07 to deal with the admissions requirements for that period. And we're also elected as a diamond supplier with International and we're very excited about expanding our opportunities into Asia, and I will be talking about that a little later. So, Bard, you want to give us some details on the numbers?

Yes, thank you very much and good morning to everyone. What I would like to do this morning is put this year's performance in context relative to where we have come over the last two years and talk about the performance within the year, zero in on our fourth quarter performance and finally end up talking about the financial position of the Company, which as Dave mentioned, is very, very strong.

To put this year in context relative to the past two years, let me start from the low point of fiscal 2002. And since this time, we have seen steady improvement in the overall sales and profitability. In fiscal 2002, our sales have increased at a compound annual growth rate of about 6 percent, reaching a record as Dave mentioned of 1.2 billion in fiscal 2004. Commensurate with this growth in sales, our earnings before the impact of the cumulative accounting change described in our press release have grown from 70 cents a share in fiscal 2002 to $1.19 a share in fiscal 2004. The earnings improvement this fiscal 2002 reflects continued strength in our North American O.E. business where we have seen the operating margins grow from 14.5 percent to around 16 percent and in Europe where the operating income has doubled and the margins have improved from 7 percent to nearly 11 percent.

Underlying these margin improvements is the closure of five manufacturing facilities and the rationalization of our product offerings, which we have discussed with you in the past. But to declare victory would be premature. Our return on average capital employee has gone from 4.1 percent in fiscal 2002 to 5.8 percent in fiscal 2003 to 6.7 percent in fiscal 2004, which is still short of earning our cost of capital of roughly 10 percent. We understand the challenge and we're focused on further growth in our return on capital employed driven by the following -- certainly, the continuance of driving operational improvements and containing cost to the establishment of stretch targets in making choices. We also expect the benefit of leveraging our installed capital base to support the new programs and the recoveries in our markets that Dave talked about. And finally, to drive the return on capital employed, we continue to exert a high degree of discipline of injecting new capital into the business, such as our recently announced Korean opportunity and addressing underperforming parts of our business.

Let's turn to the performance within the year. As Dave mentioned, we had signaled early on that the year's results would be driven by strong second half performance. This year can be best characterized as a tale of two halves. During the first half of the year, we saw our net earnings fall as higher income from licensing of certain technologies was more than offset by a decline in income from operations as we incurred costs to launch new products and recognize the impact of program scope changes. As expected in the second half, we saw the impact of the new programs with our sales increasing by 16 percent and net earnings increasing by about 40 percent.

As we look to the fourth quarter, our sales increased by 18 percent, or 11 percent if you exclude the impact of net favorable currency exchange rates, reflecting the impact of both new programs as well as the start of a recovery in our North American truck and off-highway markets. Our net reporting earnings increase by 55 percent, driven by the following -- a positive conversion on the incremental sales, which on a gross margin basis, converted at 25 percent; the impact of my property gains, which totaled 1.9 million on a pre-tax basis, partially offset by higher SG&A, reflecting the foreign currency translation of European expenses, higher testing related costs in Europe and increased benefit related expenses.

In terms of the segment results, we saw an improvement and the O.E. business, resulting from new programs and the impact of recovery of certain North American markets. The distributed product segment operated at nearly breakeven in the quarter with a favorable variance coming largely from improved but still challenging results from our aftermarket business. And the European operations segment posted a decline in profitability, reflecting the higher SG&A impact previously referenced, the foreign currency impact of the Hungarian forint, and expenses associated the start-up of the new Wackersdorf facility.

Finally, turning to the financial position of the Company, this is the fourth year in a row where our net cash from operating activities exceeded $100 million. We utilized this cash to fund the stepped-up capital program, largely in support of completion of our investments in Europe. We funded our dividend, which was increased by 10 percent to a rate of 55 cents a share and we continued to reduce debt, bringing our debt to capital ratio down to 13 percent. We ended the year with a cash balance of $72 million and debt of $88 million for a net debt position of 16 million. Dave, I'll turn it back to you.

Thanks, Brad. So what does next year look like? Well, certainly finishing the way we did, we have graded some expectations. We're absolutely committed to increasing shareholder value and the key is we must execute, have good conversion on the incremental sales, both from the new programs that we've mentioned, as well as new programs that we will be launching this next year, specifically with BMW and others, and the anticipated market growth, especially in the U.S. truck market.

We need to continue and will continue our strategic business development activities, similar to our Korean potential acquisition and we want to generate growth from our capital expenditures that we've had in the past -- the proposed acquisitions, the three-phased investments that we've had in Europe in creating our European headquarters, tech center and wind tunnel, the very successful new facility we have in Wackersdorf, Germany that supports BMW and our new plant in Taiwan for our electronics cooling business. We will continue to be focused on the four corporate priorities -- improve profitability, financial stability, new products and technology, which allows us to differentiate; and strategic planning and business development. We expect the positive momentum to accelerate and we look to deliver a similar improvement in both sales and earnings for fiscal 2005 as we have in '04.

I would like now to turn to the acquisition, the pending acquisition in Asia. I will reference -- there is a PowerPoint on our website that highlights a lot of details about this. I am personally very excited because it gives us a real presence in Asia. We have been very strong in North America historically over the last 10 years. We've been very aggressive in growing into Europe. We now have a presence also in South America, but we have missed this leg in Asia. And this is very exciting for us, not only in Korea, but in China. It creates a platform for us to grow in the region. They bring complementary products to us as we bring complementary products to them. It aligns us with one of the largest vehicle -- fastest-growing vehicle manufacturer in the world, namely Hyundai, and supports new and existing customers that we already served well in our current core businesses that allows us to serve them much stronger in the Asian arena. And finally, it establishes a strong technical presence and a world-class headquarters with a wind tunnel built by the same manufacturer that built ours here in Racine. So we're very excited to have this technical base in Asia which will allow us to support those global customers in that region. Brad, would you like to comment on some of the numbers in regards to the proposed acquisition?

Certainly, Dave. And I certainly share Dave's thoughts in terms of the significance of this acquisition to Modine, in terms of the strategic points that Dave raised. I'm also very placed in terms of what this will do for Modine from a financial standpoint.

In terms of the impact on our margins, the EBITDA margin from this business of 13 percent compares favorably to Modine's of approximately 10 percent, making this acquisition accretive. We see similar accretion benefit on our EBIT margin with the ACC division at 7.6 percent and Modine at 5.8 percent. And finally, we believe this will have a positive impact on our return on capital employed.

I would also add that this business is expected to generate excess cash flow which can be used for further growth in Asia or repatriated to North America. The acquisition purchase price is $88 million, which is comprised of about $83 million in cash and $5 million in assumed long-term liabilities. The value represents slightly less than four times EBITDA and we plan to finance the acquisition with approximately 50 percent coming from a reduction in our excess cash balances and the remainder, roughly $40 million, through drawing on our line of credit.

Let me finish with the earnings impact. We expect this to add between 7 and 11 cents per share to fiscal 2005 results. I would note the following on this calculation -- the amount is net of financing-related cost, so this is what we would expect to hit our EPS. And finally, it assumes seven months of contribution from the business in fiscal 2004. Let me now open it up for questions and answers as it relates to our earnings release, as well as the Korea opportunity.

(Operator Instructions) David (indiscernible).

Hey, good morning. I just want to clarify the earnings guidance for '05. If we used your $1.19 versus $1.02 before the accounting change in '03, that implies about a 17 percent increase in earnings, and you are saying you are expecting a similar increase in '05. Is that including the acquisition, or is that just in operations?

That is existing operations. And certainly, Dave, there is a lot at this point to -- a lot of unknowns, in regards to next year. I think the positive trends on volumes, both in truck and off-highway volumes are very encouraging. What is key for us next year is not necessarily the automobile build, but the platforms that we're on because we're very specific. If the vehicle is successful, we are successful. And certainly, the word inflation is starting to creep into some of our vocabularies and the marketplace is certainly very conditioned, both on the consumer side, as well as the expectations of Tier ones and Tier twos as negative pricing. So there are some challenges out there for this next year that we have to overcome. But at the same time, I think we have great opportunity for next year because of the incremental business and the market trends that we're seeing. But our estimate is excluding the acquisition.

Okay. So Brad or Dave, you're looking at $1.40 plus 10 cents from the acquisition. Can't you do $1.50 and whatever the truck cycle does?

Dave, I'll leave the math to you.

David, I knew you were going to say that. But I think that is right in terms of Dave's response of leaving the math to you. But clearly, we've tried to be balanced, as Dave said, in terms of the guidance that we've given. As we move throughout the year, we clearly as we have done in the past, will get more specific than we have here. And again, it's as we see the market materialize and the events that Dave talked about materialize, then we will be able to get more specific guidance.

Could you give -- (indiscernible) a couple of stand-bys and what happened in Europe this quarter. If you strip the currency, revenue was flat and EBIT was off a bit?

I would be happy to do that. I think the revenue was actually on a dollar basis, was up. The volume was down just slightly, but really what's going on there as I mentioned is really the impact of the increased testing costs that we had, the Hungarian forint, which had an adverse exchange rate impact, and then the impact of the start-up for the new facility Wackersdorf facility, were really become contributing factors to be profit decline.

I will just add a comment there, Brad. The area that I'm encouraged with in regards to our focus in Europe is our heavy-duty side. We have enjoyed considerable success in the automotive side in Europe, but we have focused very similarly in Europe in our off-highway piece and track piece as we were in North America over the last four or five years as we're being more selective in our product offering, doing a lot more standardization work, doing some rationalization of the both products and customer base. And we're starting to see that result in the numbers in our off-highway business. And we went to continue to leverage our strong position with some of our global customers. And I think with our announcement in Asia, that will actually help that business in Europe as well as we are going to hook up with a number of the both off-highway and truck folks over there.

Last question for Brad, just the CapEx and D&A for '05?

CapEx and D&A, depreciation -- let me just say this, David. I'm not going to give a projection on depreciation and amortization, but it will be up slightly because the overall capital base, as you know, has come up this year because we spent in excess of depreciation. We are projecting though from a capital spending is that, again, as we have said all along that fiscal 2004, which we've just completed, was a peak year as we finished up the large investments in Europe. And therefore, we expect in the future to invest at or below our depreciation rates as we go forward. And that, again, ties right into the comments that I made on the return on capital that we are now able to kind of leverage the installed capital base to drive the returns on capital in the business.

Okay, thank you very much.

Laura Thurow, Robert W. Baird.

Good morning. My first question for you this on the Wackersdorf facility, it sounded like it was still a cost to you in the quarter, so that is going to be a god source of margin improvement going forward. As volume ramps up there, is that the case?

Yes. We actually in the fourth quarter had two facilities in operation in Wackersdorf. The first one was supporting the Series One product line and it was only a line sequencing to one BMW facility, although it was serving the global needs for Series 3. With the growth that we have enjoyed with BMW, we outgrew that facility. And it was a leased facility actually from BMW. And what we have done is build a plant relatively close, but it is now going to serve Series 3, because we have the carry-on program, but also a new Series 1 X3, Z4. And during fourth quarter, we had duplicate facilities. And the old Wackersdorf facility has now been shut down and there's no ongoing costs with that beyond last fiscal year to my knowledge. And most of the launch issues are behind us. We had some in the fourth quarter at the new facility. Not significant, but anytime you bring a new plant up, you have some issues. So, yes, I think your observation is right is that we should be able to leverage now that growth with launch of some new product out of that plant, as well as leveraging the new technology that we put in there. The plant wasn't a cheap date, so we have to make sure that organization performs.

Great. And then on your new distributed side, you said you were breakeven in the quarter. What is your kind of strategy for either growing the business and/or improving profitability in that?

Well, that's a three-legged stool in that business. We have our HVAC in our business, or what we traditionally called the heating business. And I'm very pleased with that group over the last few years. We've done some restructuring, we've closed a facility, we've done some rationalization and our earnings have improved nicely in that business. And we're going to key to focus on that market and look at strategic opportunities to supplement the capabilities in that business.

The other two pieces of that business is, one, the electronics cooling business, formally known as Thermacore. And certainly the market recovery is starting to hear noise in the telecommunications side. We're getting more inquiries, but candidly, we're not seeing any volume in that marketplace yet, but I think it is a matter of time. We have refocused our resources in that business more to the consumer products and even the consumer products side is growing for thermal solutions beyond the traditional extrusions and fans. And that is what drove us to having the new facility in Taiwan to support both laptops and desktop units.

We continue also in that business to evaluate their breakeven. It is a dilutive business for us right now. And we don't want to impair the business, because I think long-term, the acquisition has huge upside opportunities for us as the technical needs for that business accelerate. But we're going to continue to challenge ourselves in regards to the breakeven point of that business and we need to make sure that we are where our customers are in that business. And so would see us further expanding into Asia and probably China in the not too distant future to support that business.

The final one and the because piece of the distributed products that we've been very candid in the past is the aftermarket. It's been a great business for us, but many of the fundamentals have changed in regards to customers and distribution costs, product lifecycles, etc. I'm very pleased with that organization this last year and that improvement you noted is primarily from that business, actually more than the numbers show. And I'm really pleased with the way some of the rationalization -- we've sold Canada, we've done some other things that have brought value to the bottom line. We've worked very hard on our distribution cost and our acquisition cost and we had made progress. But certainly, that segment report is not acceptable. So I think we need to continue to work and we are on as much of the strategic alternatives for this business. Further downsizing certainly we evaluate in regards to making sure we understand a piece of that business as those that contribute and those that don't. But there are other strategic alternatives for that business and we're going to continue to work that ball.

Great. Briefly, and I'm sorry if you said this already, I might have missed it. But currency impact on sales and profit in the quarter?

Yes. Laura, it's -- look at the impact of currency in the fourth quarter, in terms of the pretax earnings impact was $1.7 million as we put in our press release. And the impact on our sales was 17.9 million.

Great. I'll jump back in the queue.

(Operator Instructions). Laura Thurow.

I thought I would get back in line, that was a good wait. Question on your tax rate in the fourth quarter. It was higher than we were looking for. I guess what was behind that and what are you looking for going forward?

Yes, let me just respond to that. The tax rate at 42.9 percent was higher in the quarter. It's certainly higher than the average rate for the year at 36.5 percent. We did take a look at some of our, what we call deferred tax assets, which are tax loss carry forwards that we have on the balance sheet as an asset because they have value as we go forward and as businesses are able to utilize those. And we took a look at those and we did make a valuation adjustment, which means we put a reserve against those. So that the impact of boosting our tax provision in the quarter, which did boost up the tax rate to the 42.9 percent. As we go forward, I've said before on these calls that a tax rate in kind of the 35-37 percent range is where we would expect to be operating on a normal basis as we go forward.

Okay. I have a follow up on the acquisition. Just looking at some of the numbers if I just take ACC's operating income and extrapolate interest expense and using your tax rate, it looks like it could be on a full year run rate maybe 20 cents or maybe 25 cents, but using kind of the 7-11 cent range and annualizing that, I get a plus 15 cent number. What's the variance there?

The variance, we clearly as the business goes forward and they launch new programs, we expect the overall sales to improve in that business, not significantly. We have not, in our acquisition valuation, we have not counted on a significant improvement in sales. So we do actually though expect there to be some moderate growth in sales. We have worked tom be prudent, in terms of the numbers that we put out there. There will also be some costs that we incur in terms of the integration of that business this year and we have factored those into our estimate.

Laura, I would just add that certainly, I'm real proud of the job that the whole team did, in regards to developing this opportunity and going through the process of where we are at. And certainly, we have to get the deal closed. We have already put in place to make sure that the integration brings the value to the shareholders that it should, is some incremental resources into the program, both in managing our larger footprint now in Asia, but also some specific resources, incremental resources, in managing the integration of this business in not only making sure that we understand it, but also we can leverage their technology and our technology. So how that ends up in the bottom line on a full year basis, I hope your math is right, but stay tuned. One thing that Brad and I are learning is we're acquiring a taste for kim chee. So we have to make sure we can relate to our new employees.

Absolutely. That sounds like a great opportunity. That's all I have. Thank you.

David (indiscernible).

Just a quick question on the building HVAC business which you don't talk about a lot but I think it's been nicely profitable. Would you say that business is on average higher than Modine's corporate average, in terms of margins?

David, In terms of the Modine corporate, it might be a disingenuous comparison because the Modine corporate has in at the SG&A assets held at the corporate level. So that answer to that question is yes. But again, I would say this, that if you look at it excluding the corporate impact, I think it's fair to say that the HVAC&R is certainly one of our more profitable businesses on a contribution basis, contribution as a percent of sales.

Great, thank you.

John Halmer (ph), Caldwell Securities Inc.

Good morning.

Hi, John. It's been awhile since I've heard from you.

Yes, indeed. On the consolidated statement of earnings, other income -- those numbers look not only significantly bigger than last year, but just big in absolute terms. What is other income?

Let me respond to that. The other income is where we record, as I mentioned in my talk, that's where we have our license fee on certain technologies that we have developed that we have licensed to others that's included in the other income. The equity earnings that we have, as Dave mentioned, we have a very, very good footprint, for example, in Brazil, that the equity earnings from our Brazilian joint venture, from our French joint venture and also from our Japanese joint ventures are in there. And we have our interest income. And as also we mentioned, we have the gain on the sale of certain assets that come through. So the comparison, clearly, as you have noted, is up significantly versus the prior year. I would note that, again, this year we had gains on our divestments versus last year. We had a loss on our business in Canada. And our royalty income is up, and again, our equity affiliates; that is, again, our Brazilian and French and Japanese affiliates, are showing a positive earnings improvement.

Okay, thanks.

Thank you, John.

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

Thank you, operator, and I'd like to thank everybody's participation in our year end and fourth quarter conference call and I look forward to reviewing our first quarter results and maybe a better look at the full year in our next call. So have a great day.

Thank you.

This concludes our conference for today.