Modine Manufacturing Co (MOD) 2014 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the Modine Manufacturing Company Q1 2014 earnings call presentation.

(Operator Instructions)

I would now like to turn the call over to your host for today, Ms. Kathy Powers, Vice President, Treasurer and Investor Relations, mam you may begin.

Thank you. Thank you for joining us today for Modine's first quarter 2014 earnings call. With me today are Modine's President and CEO, Tom Burke and Mick Lucareli, our Vice President in Finance and Chief Financial Officer. We will be using slides with today's presentation. Those links are available through both the webcast link as well as the PDF file posted on the Investor Relations section of our website, www.modine.com.

Also should you need to access 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 first quarter results and provide updated revenue and earnings guidance for fiscal '14. 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 include forward-looking statements as outline 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.

Thank you Kathy and good morning everyone. I am pleased to report that Modine started fiscal 2014 with a strong quarter with both revenue and earnings improvements. We delivered adjusted earnings per share for the quarter of $0.27, up $0.20 from the prior year.

Our revenues were up 7.2% with year over year sales increases in our Europe, South America, Asia, and building HVAC businesses.

As expected market conditions in South America and Asia are improving and we are also beginning to see higher volumes in our commercial vehicle programs in Europe. That being said we remain cautious about the commercial vehicle markets in North America and Europe and believe these markets will remain challenged for the remainder of the fiscal year.

Mick will provide some more details on the financial results in a few minutes, but first I would like to comment briefly on our segment results and outlook.

Turning to page six, revenue was down 3.2% in the North America segment, primarily driven by continued weakness in Off-Highway markets. Sales to commercial vehicle customers were flat with a slight increase in Mediums, offset by a decrease in Heavys as compared to a strong quarter last year. However sales to automotive customers were up versus the prior year.

Looking forward we expect mixed market conditions in North America to continue in fiscal '14. We expect Heavy truck production to decline about 5%, medium truck production to increase 5% to 10%, and the broad overall Off-Highway markets to grow 5% versus last year.

I want to remind our shareholders that we mostly participate in the Heavy segments of the Off-Highway markets which will not see this level of growth for this year.

Please turn to page seven. Our Europe segments year over year sales were up nearly 17% in the first quarter, driven by higher sales of products to automotive and commercial customers along with higher tooling sales. The increase in sales in commercial vehicle customers was evenly split between the new Euro 6 programs and a pre-buy effect of existing truck platforms.

Last year was a difficult year for our Europe segment as sales were impacted by weak economic conditions, the BMW bid module business wind-down, delayed launch buyings and unfavorable currency conditions. Although economic conditions remain a concern we anticipate that these factors will have less of an impact on our results this year.

We expect commercial vehicle production to decline about 5% year over year. We do anticipate a continuing decrease in BMW sales this year, although most of the negative effects of this program wind-down, are behind us. In fact, due to the strength of premium auto sales in Europe we saw a limited impact from the BMW wind-down this quarter.

Challenges still remain in Europe as we still analyze our restructuring program and ramp up the volume of our new commercial truck radiator programs. While the trends are heading in the right direction we have more work to do with achieving our cost of productivity targets. I am pleased with the progress which is based on utilization to the Modine operating system and excellent team work.

Moving to South America in page eight, excluding currency impact, sales were up 16% continuing the trend from last quarter. We continue to see recovery in the commercial vehicle market and are also benefiting from increased launch volumes in our new power generation cooling program. The recent public protests in Brazil did not have a significant effect on the quarter but some shipments at the end of June were delayed until July, shifting some revenue into the second quarter.

Our outlook for the current fiscal year for this segment is for 20% growth in commercial vehicle sales after the sharp decline in fiscal 2013. We also expect to experience growth in agricultural equipment and after market volumes. We see foreign exchange rates as a headwind, as the Brazilian Real continues to weaken against the US Dollar.

Please turn to page nine, our Asia segment sales increased by 16% with increased sales in Off-Highway customers. While this is a significant improvement over our prior year it is still less than the peak level seen in fiscal 2012.

As discussed during our year end call we were anticipating that market addition would improve in this region and we are pleased to see improvements in both sales and earnings.

China's excavator market has stabilized and we expect moderate growth this year. We are somewhat cautious about this growth projections as we generally participate on the premium brand of high tonnage excavators and much of the growth is projected for the lower ranges.

However, we are seeing some strength from our Korean OE customers that serve both the Korean and Southeast Asian markets.

India's commercial vehicle markets are starting to weaken from earlier forecasts but we still expect growth of up to 5%. We remain positive on our growth potential in Asia as we are launching 50 new programs this fiscal year and our new business wins continue to confirm our solid growth potential for our Asia business.

Turning to page 10, sales in our Building HVAC were up 8% in the quarter, driven by higher chiller sales in the UK and increased heating products in North America. Our UK sales were up 21% year over year, showing both continuing recovery in market and good acceptance of our new product offerings.

In addition, we continue to see good order in take from the UK business. For the first quarter of fiscal 2014 our UK orders were 46% higher than the previous year. This was somewhat offset by the decrease in Airedale branded school products in North America.

Although we saw increase heating product sales in North America, it is too early to tell if this is restocking from the strong fourth quarter of last year or early orders for the current heating season.

We continue to have a positive outlook for this segment with growth expectations for fiscal 2014 of 2% to 4% in North American benefiting from new product growth and 3% to 6% in the UK [dealer] center cooling market benefiting from improved economic conditions in the UK versus the prior year.

With that I would like to turn it over to Mick for an overview of our financial performance and guidance going forward.

Thanks Tom and good morning everyone. Please turn to slide 12 and I will review the income statement.

As Tom mentioned we had a very strong quarter with a 7% increase in sales. This was driven by volume increases in four of our five business segments with the largest impact in Europe. Also during the quarter we recorded $2.7 million of charges as part of our European restructuring program. Of this amount $500,000 or $0.5 million was recorded as restructuring expense primarily related to severance costs.

$2.2 million was recorded in costs of sales relating to accelerated depreciation of production equipment that we plan to phase out over the next several months. As reported the gross margin increased 180 basis points to 16.5%, excluding the acceleration depreciation the gross margin and improved 240 basis points to 17.1%.

The improvement was primarily due to higher sales volume and favorable material costs during the quarter. But keep in mind, however, that we have material pass-through agreements with most of our customers. In many cases we will be adjusting our prices downward to pass along this benefit.

The SG&A expense was favorable this quarter with an $800,000 decrease. SG&A as a percentage of sales improved 100 basis points to 11.3%. This improvement resulted from the restructuring activities completed last year in Europe along with lower professional fees.

Income taxes increased $2.9 million year over year resulting in an effective tax rate of approximately 32%.

And excluding restructuring charges and the accelerated depreciation adjusted earnings per share was $0.27 for the quarter, exceeding the prior year by $0.20.

Turning to Slide 13, pre-cash flow was positive at $5.7 million in the quarter. This was driven by the combination of higher operating cash flow and lower capital spending. Q1 actually represents a $12.6 million year over year improvement driven almost entirely by the increase in operating income.

We often see a working capital build during the first quarter but our business segments did a good job of managing through the increase in revenues. Our target for full year capital spending is $60 million to $70 million which is higher than last year but still lower than historical levels.

And the stronger cash flow is certainly helping our balance sheet. Net debt- to-capital is at 33% including $31 million of cash.

Moving onto Slide 14, let's take a closer look at our North American segment on the left where first quarter sales were down 3%, but despite the volume decline the segment performed well and gross margin actually improved versus the prior year.

Gross margin was up 180 basis points benefiting from favorable material costs. We also benefited from a more favorable product mix which resulted in lower labor costs. Assuming stable markets for the metals I would not expect this benefit to continue as the pricing mechanisms in our past-through agreements kick in.

SG&A increased as expected by $1.4 million on a year over year basis. This was due to higher compensated related expenses and lower recovering of testing and development costs as compared to the prior year. Overall operating income for the segment increased $500,000.

Now looking at our European business segment, we had a very solid quarter in Europe with sales up 17% or $21 million from the prior year. Our gross margin increased by a 150 basis points due to higher sales volume and the favorable material costs.

As I previously mentioned Europe's costs of sales include $2.2 million of accelerated appreciation. Excluding these costs the gross margin was 14.7% a 300 basis point improvement over the prior year.

Despite this good news we are still working through launching efficiencies in Europe that are keeping our margins below targeted levels.

Contributing to the quarter was $1.8 million decrease in SG&A which was the direct result in restructuring actions taken last year and lower professional fees. Also in the quarter was $0.5 million or $500,000 primarily related to severance costs. Excluding all the restructuring related costs operating income year over year increased $8 million on an apples to apples basis.

Moving onto slide 15, we have a look at our South America, Asia business segments. Sales were up 16% in South America excluding the impact of the devaluation of the Brazilian Real against the US Dollar and this is compared to the 10% as reported. Again, we are pleased with the year over year gross margin in this segment continuing the trend from the prior quarter.

Gross margin was up 260 basis points to 17.8% on higher sales volume and some improved aftermarket pricing. South America had lower SG&A expense on the higher sales volume, primarily related to the lower employee costs. As a result operating income for the segment increased $1.9 million.

Now looking to the right side to our Asia business segment. Gross margin improved significantly on the 16% sales increase. The Asia segments margins also benefited from favorable product mix and material costs.

SG&A expenses were slightly lower due primarily to cost control measures taken last year to lower our breakeven point for the segment. Although we still reported an operating loss, it represents a significant move toward profitability and improvement year over year. As Tom mentioned, we have significant launch activity in Asia that should continue to add much needed sales volume.

And on slide 16 is our Building HVAC segment. From a seasonality perspective Q1 is always a quiet quarter. Sales were up 7.6% and the gross margin held steady with the prior year. SG&A increased $600,000 from prior year due to higher commission rates on certain products and the additional hiring to support future growth.

As a net result operating income was flat with the prior year.

Now lets turn to our fiscal 2014 guidance on slide 17. As Tom outlined, we completed a strong quarter with year over year increases in both revenue and earnings. Given this performance we are increasing our full year guidance. We anticipate revenue growth to be in the 3% to 8% range. This is an increase from our prior range of flat to up 5%.

We anticipate adjusted earnings per share to be in the $0.50 to $0.60 range and this is up slightly from our previous guidance of $0.45 to $0.55. This change in guidance is primarily the result of the strong first quarter. Given many uncertainties we are not significantly changing outlook for the balance of the year. We remain cautious about some of our major markets.

The North America Commercial Vehicle and Off-Highway markets are challenging to predict based on trends. In Europe the Commercial Vehicle market has the potential to have a pre-buy which could impact sales on the Euro 6 trucks later in our fiscal year.

And with regards to sequential trends, we need to factor in a number of items. First, as many of you know seasonal production schedules in North America and Europe reduced the number of production days in Q3 and Q2.

Also most of our commercial agreements include material pass-through provisions so we will be adjusting prices down for many of our customers which will impact sales and margins for the balance of the year.

And finally given our restructuring activities and current mix of earnings our tax rate is difficult to predict. We currently estimate taxes will be in the range of $13 million to $15 million, which is up slightly from our previous expectations.

Despite our caution we are quite pleased with our first quarter results and the ongoing positive trends in the business. With that Tom I will just turn it back to you.

Thanks Mick. I am going to turn to page 18. As I mentioned it is great to see fiscal 2014 off to such a great start. We anticipated that our markets would start improving this year and are encouraged to see the positive impacts of this initial recovery of our results.

In addition to the market improvement we are also benefiting from our significantly improved cost structure, favorable material costs, high volume and content of our commercial vehicle programs in Europe.

On the risk side we are forecasting continued weakness in the Heavy-duty Commercial Vehicle markets in North America and Europe. And in addition, as Mick mentioned, our customer material pass-through agreements will begin to somewhat neutralize the benefit of our lower material costs we have realized as we share this benefit with our customers.

And finally challenges still remain in Europe as we finalize the restructuring and begin to ramp up the volume of our new Commercial Truck programs.

Overall I am very pleased with the performance of our segments. Our teams are effectively executing their plans. With our improved performance and cash generation we are currently valuating new opportunities to accelerate growth in our current as well as in new and adjacent markets.

And with that we would like to take your questions.

(Operator Instructions)

Our first question today comes from the line of David Leiker of Robert W. Baird, your line is open, please go ahead.

Good morning everyone.

Hello David.

A couple of things I want to dig through here. Mick if we got started with the tooling revenues, is there a way you can quantify the size of that and then talk a little bit about the economics of how it impacts profit and margins?

I tell you what David while we are on the Q&A here I will see if I can actually dig out the actual tooling revenue for you. We are happy to share that. As far as the economics go, generally it is shows up in revenue and the costs show up in cost of sales.

But it is not a big margin impact. It can vary a little bit but generally it is a more of a pass-through item. I would say on average our markups on tooling can be 5% to 15% maybe with a 10% average.

Our customers allow us to market it up a little bit, obviously for the process of designing, developing, qualifying, ordering the tooling but the bigger issue is it can sometimes skew the top line results and depending on the size it can adjust the gross margin a little bit.

Is this reimbursement from your customer for tooling you are putting in place?

Correct, it is customer owned tooling.

Okay, great. And then on Europe, I understand the Euro 6 piece of it. I didn't think you had a lot of exposure to a pre-buy on that. Could you put some more color on what you are seeing there?

Clearly on the radiator side, which we have always been talking about, we have a 10% to 12% market share currently but we have other components to go in such as, oil coolers and products that come out of our Hungry facility that we are in that business as well. With the pre-buy effect we have seen increase in business in sales with that.

Okay, that is great and then on the gross margin. One of the things we are seeing with other companies, as we entered the June quarter with a cautious view on the markets, we clearly saw some upside in production during the quarter and that created a better contribution margin than normal. It seemed like that is the same type of thing that you experienced here?

In the current quarter Dave? Or are you talking about the quarter we just closed?

In the June quarter.

Yes, I would agree.

Okay, I will come back with some other ones. Thanks.

Okay.

(Operator Instructions)

Our next question comes from the line of Ann Duignan your line is open, please go ahead.

Good morning, it is [Mike Siwinski] filling in for Ann.

Hello Mike.

Hello, just wanted to quickly dive into some of the upsides that you guys saw from raw materials during the quarter. I know that of it is going to be given back in future quarters, but could you tell us which raw materials were the source of the upside during the quarter and maybe a bit about how you're buying works? Do you have contracts? Do you have to go into the spot market to price the raw materials from each product?

The largest impact for Modine, by far, is aluminum. And then next in line would be copper and then stainless steel. It just depends upon the supplier and the supply base, but generally we have got about probably a 60 day to 90 day order in visibility, I would say to our costs.

By the time we order it, it is delivered and flows through our facilities. Generally it is about 60 days to 90 days out as we have a pretty good view of material costs that we will be paying.

As we sit, say the end of June, we have got pretty good visibility into September quarter of our costs. Then what happens is we pass-through, we adjust with our customers the prices for changes in the spot market. Either every quarter, to every six months and in some cases with a few customers, once a year. So what we wanted to make sure we pointed out in Q1, here, is we actually had some nice tail winds for once.

You have certainly heard from us enough where it has worked against us. But metals have continued to hold flat and actually come down. Which as our prices have held with our customers there have been some tail winds. But as we move through the year, now that aluminum has leveled off, that will start to level off and better match the pricing in our cost of sales.

Okay great, switching over to Europe, could you give us a little bit of insight into how much more content you will be having in Euro 6 vehicles versus Euro 5?

Yes, we have coming off the previous question, obviously most of our discussion has been revolving around the radiator launches that are involved with the Euro 6 conversion.

But I also want to point out that we have significant other content that is on Euro 5 that is also being carried over and in some case in Euro 6 that would include oil coolers, EGR coolers that are also new in some cases and other specially components that go into that besides the radiators.

So if you take what was kind of the traditional base line and add the radiator content and add the EGR content we are picking up quite a bit of content with Euro 6 launches.

Okay great. One last one here. Just kind of putting it all together. You have restructuring over in Europe, you have a change over in the emission standard and two other things that are transitioning in that region. Is there a date that you could maybe tell us that you think you will have everything down and you can go forward with a different cost structure and full Euro 6?

Yes, the remainder of this fiscal year is going to be a lot of work in Europe. And that is why I made the point, specifically.

Let's first talk about the launches. The launches on Euro 6 have been delayed and coming on late so we are really going to see on the other side of the calendar year, now, and going the slow ramp up through our Q4 or Q1 of the next calendar year, the ramp up rate into Euro 6 as registrations can no longer be accepted for Euro 5 trucks in Western Europe. You will start seeing the big ramp up towards the end of Q4. Our Q4 fiscal year.

As far as the restructuring is concerned we have really have had the pedal to the floor on getting work done. We re coming into final stages. As I might remind our listeners we are down to three remaining manufacturing facilities and we have consolidated our administrative facilities from three separate buildings into one.

And our tech center that has also consolidated. That footprint change needs to keep moving and by the end of this fiscal year we want to have that plan finalized and all financials taken care of to demonstrate where we are going that you can get grounded on. And I will let Mick add to that.

Just a couple things from the financial side from Europe and the progress. The SG&A, that run rate and the hard work is really done there. And as Tom laid out we are at the final phases of consolidating and finishing our plant restructuring.

Most of those severance costs are behind us, we will really start to see the benefit from some of the overhead absorption and benefit when volumes recover. So I would say we are two-thirds, three-quarters of the way through the plant restructuring.

And then the last piece that we still need to do a little bit of work on, we had a goal to reduce the overall asset base in the region and Tom pointed out we have moved out of one headquarters and into a different facility, we have done some other things.

We have some other work to do, just with regards to asset consolidation. Our plan would be to get that done this fiscal year. Volume would be the item that would accelerate or slow down the rate of earnings improvement that we would also see.

Okay. I guess that presents one more follow up on my previous question. From a dollar perspective to you happen to know how much more you can expect on a Euro 6 truck versus a Euro 5 truck on your revenues?

From a content perspective? You are looking at an average content per truck number, Mike?

If you can give it, yes?

Well, I mean, obviously, I would say that our average content by the time you added the radiator, EGR coolers, oil coolers, SDK coolers, fuel coolers and the like, is obviously in the four figure number per average vehicle.

And the number of vehicles they are going to be on is going to go up significantly Euro 5 to Euro 6. So, while I can't give you an exact number the average content and the volume are both going to go up in the right direction.

And as far as pricing and the dollar per vehicle, I would say, Tom unless you disagree, would be about the same as what we have seen. Probably the biggest driver, as Tom mentioned, is our market share gain in the truck market. So it will be more of the unit driver than a sales per unit.

Okay, great, I will hop back in line. Thanks so much.

Our next question is a follow up from the line of David Leiker of Robert W. Baird, your line is open, please go ahead.

Just a couple ones to follow up here. On the Commercial Products group, it sounds like you have got some pretty good end market drivers there, but doesn't seem to be showing up on the margin line. Can you talk a little bit about that?

Yes, good question, David. We for the last, I would say, three or four quarters, you have heard us talk about accelerating the rate of growth in that business segment.

So that is required. Frankly, it was kind of a sleepy business at Modine and didn't get the investment that it deserved. So, for example, when the company was spending...at the time when we were spending $80 million to $100 million in CapEx, we maybe spend $3 million of capital in that segment.

We have had to increase our spending a little bit. We bought the Geofinity business, we have come out with some new product line and we have had to hire engineers and people to not only develop these products. Our new ventilation roof top system, so right now we are at the front end of that curve.

So what you are seeing is we have got a short term increase in our costs while we re ramping up now the product development is basically behind us. Now we are starting to ramp up the sales of those new products and we should start to see that come through in earnings, David.

Do you think you can get back to that 10% margin you had in the past?

Yes, absolutely.

Definitively.

What is the time line on that, 12 months, 18 months, 24 months?

I would say as we look out, and obviously this quarter is always hard because historically in Q1 it is right between all there seasons. It is always nearly a break even quarter. But as we go through the year we expect to get back closer to the 10%. Operating range certainly by Q3 and Q4, in that range. We will probably end the year a little bit below it but this will clearly improve sequentially as we go through the year here.

Okay, and then a similar question on North American business. You have got really nice margins there. I think it is probably the highest in a long time. How sustainable is that? And do you think that moves one way or the other. I am sure materials are going to play a role in this.

Yes, I can take the first stab and let Tom add anything. I think we would be the first ones to tell you that a 17% gross margin, while we are real happy with it, scares us a little bit. And I think we can sustain a 16% to 18% up and down depending on volumes and metals.

But, no I think it is going to hover and call it the 16% range. We had some nice tail winds behind us and certainly there sill be quarters or periods as you know that the truck market and other end markets will be going crazy and we will have leverage from a fixed cost.

This quarter, obviously, with volumes down and margins up this was a little bit off with a tail wind of metals. You are right, it is probably a little bit lower than that on a long term basis. Tom did you want...?

No, I would agree with Mick, we have great operating leverage in North America with the restructuring complete. The team has proven it will convert on top line sales so the focus on productivity in the plant should assure that Modine is delivering the results. Low material costs has definitely been a little sugar high that we have been enjoying here this last quarter.

So theoretically, 12 months from now when we are through the launches in Europe and restructuring is done, you see a similar type of move in that European segment?

Yes

We were targeting getting above 15% as our first step and, you know as I said, without that accelerated appreciate in the quarter we were about 14.7%. So a little bit more room to go and that will be the volume that we need in Europe since they have a higher asset base than North America.

And then the last item here is on China. It looks like given the numbers that you have your break even on the $70 million. Which I think is lower than we've talked. Has that come down lower or is there something else there that is helping?

We have great attention in that region and they are working hard to manage both the cost side, but more importantly, or as importantly, obviously the growth side. That is why I wanted to mentioned these 50 launches that are coming through the pipeline now, so we are clearly going to blow through that break even point over the next 12 months as these launches come into play. And coming out of this fiscal year and into next fiscal year. Probably [$85 million] is a break even point and I would probably say we are a little conservative on that but they are doing a great job over there.

Yes, I would agree, David. I think we will watch. As we finally get the volume coming through we have our predicted margins we have it all modeled out and I was really happy to see the margin this quarter. We like to see a few more quarter, right now I think we will hold to that [$85 million] range. But I see your math and a couple more quarters if we see sustainability we will come back and address that.

And then the sales increase here. I understand that Korea is a bigger part of it than China. Is that market driven or is that organic growth?

Most of that in the current quarter was market driven. We saw some really good volumes with Volvo and HHI. And I think a lot of that was on excavators actually and other construction being shipped to Southeast Asia.

Okay. And Tom, since you opened the door on the 50 programs, can you put any type of frame around the revenue opportunity that those have and the timing for it?

Right now I am very comfortable to say that we are going to very much exceed our breakeven point going into next fiscal year with those launches. I mean that is probably as far as I want to go right now, but it is significant business, we are very pleased and we are looking forward to a very good fiscal year in the Asia region next year.

David, if it helps too we have got a real hard push. While we want to get to break even at the $80 million to $85 million range we have got a hard push to get to $100 million range. And the little bit of market growth we see but even more on these program launches and another nice thing they are on a different product, an oil cooler that also gets us more diversified in automotive. That gives us a lot of confidence and visibility to get the segment to $100 million range.

Okay great, thank you very much.

One thing, just to follow up on the call. David asked about tooling. Year over year tooling was up about $3 million of the $25 million. A little piece was in there but not a significant driver and not a material to the earnings of the company.

Great thank you.

And with no further questions in queue, I would like to turn the call back over to Ms. Powers for any closing remarks.

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

Ladies and gentlemen thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of the day.