Modine Manufacturing Co (MOD) 2014 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third-quarter fiscal 2014 earnings call. (Operator Instructions). As a reminder this conference call is being recorded.

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

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

We will be using slides for today's presentation. Those links are available through both the webcast link as well as a PDF file posted on the investor relations section of our Company website, Modine.com. Also should you need to exit the call prior to its conclusion, a replay will be available through our website beginning approximately 2 hours after the call concludes.

On slide 2 is an outline for today's call. Tom and Mick will provide comments on our third-quarter results and update our revenue and earnings guidance for fiscal 2014. At the end of the call there will be a question-and-answer session.

On slide 3 is our notice regarding forward-looking statements. I want to remind you that this call may contain forward-looking statements as outlined in today's earnings release as well as in our Company 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'm pleased to report for the third consecutive quarter that Modine has reported year-over-year growth in revenue, earnings and cash flow. We delivered adjusted earnings per share for the quarter of $0.16, up $0.14 from the prior year and our revenues were up 6% primarily driven by sales increases in Europe and Asia along with strong North American heating product sales in our Commercial Products segment.

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

Turning to page 6, revenue was up 1% in North America. Higher sales to commercial vehicle and automotive customers offset a decrease in sales to off-highway customers. The North America off-highway segment continues to be pressured by weak demand particularly for agricultural and mining equipment. Construction markets appear to be stabilizing and some cases show signs of improvement.

Automotive and light-duty orders remain steady and we are pursuing additional opportunities in this area as cafe standards continue to drive the need for additional engine and powertrain heat transfer technology.

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

Please turn to page 7. Our Europe segment sales increased 21% in the third quarter driven by higher sales to commercial vehicle customers, higher tooling sales and the impact of the stronger euro. Excluding the impact of currency, sales grew 16%. The increase in sales to commercial vehicle customers was primarily driven by higher launch volumes for components for Euro 6 vehicles. In addition, about one-quarter of the increase related to existing Euro 5 programs.

As we have mentioned over the past two quarters there was clearly a pre-buy of Euro 5 vehicles that favorably impacted our revenues this year as we had the dual effect of higher sales on mature Euro 5 programs while also seeing volume [decreases] as Euro 6 programs ramped up production. As a result of the pre-buy, we expect commercial vehicle volumes in Europe to decrease by 3% to 8% in calendar 2014.

Sales to automotive customers in Europe were relatively flat as higher sales of automotive components were offset by a decrease in automotive modules as the BMW program continues to wind down. The revenue of the BMW wind down during the quarter was about $5 million. We continue to expect the broad European auto segment to be flat to up 5% in calendar 2014 and we expect to continue to see smaller declines in sales of BMW modules as the remaining programs continue to wind down.

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

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

Moving to South America on page 8, excluding currency impacts sales were down 5% due primarily to lower sales to commercial vehicle, automotive and power generation customers. Sales to aftermarket customers were down slightly from the prior year.

Earlier in the year, our South American markets had seen sales increase in the range of 20% but that slowed considerably toward the end of calendar 2013. As a result, some of our key customers took an extended Christmas holiday to work down excess inventory. We expect this to be temporary and that production will increase in our fourth quarter. In addition, last year Modine Brazil helped support our European restructuring efforts by temporarily producing product as our Europe team moved production of certain components between plants and this also contributed to the year-over-year sales decline.

Our outlook for calendar 2014 for this segment is for market conditions in Brazil to remain challenged resulting in flat to 5% growth in commercial vehicle and aftermarket sales and a flat agricultural equipment market.

Please turn to page 9. Our Asia segment sales increased by 30%, increased export sales from India to European automotive customers and increased domestic sales to off-highway customers in China. India commercial vehicle and off-highway markets continue to show weakness but I am encouraged by the growth in the export market. Export sales will be a big driver for sales growth in India particularly given the current weakness of the Indian rupee.

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

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

Turning to page 10, sales in our building HVAC business were down 10% in the quarter. This was driven by a $7.4 million decrease in sales from our Airedale business in the UK resulting from the fire that halted production at the Airedale manufacturing facility on September 6. This was partially offset by an increase in sales of North American heating products.

Prior to the fire, our Airedale business was having a great year and as I mentioned last quarter, they maintained the vast majority of their orders despite the resulting delays. In the meantime, a few of the customers that canceled their orders due to the delayed delivery schedule have actually come back to Airedale and are willing to wait for their product. We are up and running in our temporary facilities and are taking orders and are delivering product.

Although our leadtimes are currently longer than we would like, our orders are nearly to the levels we saw before the fire. We are at approximately 70% capacity and are adding an additional shift to production.

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

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

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

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

As Tom mentioned, we had another strong quarter with a 6% rise in sales. I am pleased to report that the gross margin increased by 160 basis points to 16.4%. Four of our five business segments delivered higher gross margins. The most significant drivers were the higher sales volume combined with more favorable raw material costs.

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

Please note that during the quarter we recorded $11.4 million in restructuring related items to support the final phase of our European restructuring. As Tom explained, the decision was made during the quarter to combine two manufacturing facilities in Germany into one manufacturing facility. The largest piece is $9.4 million related to employee severance costs and then there is an additional asset impairment charge of $2 million related to this program.

There is an appendix in this presentation along with more details in our public filings regarding the restructuring costs and the adjusted earnings calculations.

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

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

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

Please turn to slide 14. On the left side of the slide has a summary of our North American segment. As Tom mentioned, first-quarter sales were relatively flat. Despite the topline challenge, the gross margin improved 200 basis points to 15.5%. The improvement was primarily due to favorable material costs and other performance related material savings. Similar to last quarter, SG&A increased primarily due to the higher incentive compensation expenses and lower recovery of development costs. Adjusting for these two items, the underlying rate of spending would be roughly flat. Overall operating income for the segment increased $0.5 million over the prior year.

Now looking at our European business segment on the right side. Of the five segments, Europe clearly had the strongest quarter with sales up 16% from the prior year on a constant currency basis. The gross margin improved 180 basis points to 12.2% year-over-year due to higher sales volume and favorable material costs. As Tom mentioned, we have a lot more work to do with regards to reducing manufacturing inefficiencies with our new commercial vehicle programs and completing our restructuring.

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

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

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

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

Now turning to the right side and our Asia business segment, second quarter sales -- I am sorry -- sales in the quarter increased $4 million or 30%. Approximately $1 million of the increase is related to tooling sales. The remaining growth is tied to ongoing program launches in the region.

As discussed in previous quarters, this segment's margins and earnings are highly dependent on sales volume. You can see how the gross margin improved significantly due to higher sales volume along with ongoing favorable material costs and manufacturing improvements. While the results show an operating loss of $600,000, we are moving toward that breakeven point and this represents a $1.9 million improvement year-over-year.

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

Our gross margin increased due to favorable product mix. Sales of our relatively higher-margin heating products increased due to the extreme weather conditions and market share gains.

SG&A decreased $600,000 from prior year partly due to the smaller scale of our Airedale operations in the UK and we have not recorded income for insurance proceeds related to the recovery of lost profits. We have submitted our first business interruption claim for lost profits but we don't know yet when we will receive the first payment. Overall, this was a very solid quarter for the HVAC segment.

Now let's turn to our remaining fiscal 2014 guidance on slide 17. As a result of another strong quarter, we are increasing our full-year guidance. Our revenue growth has been narrowed to a range of 5% to 8% over the prior year. We anticipate adjusted EPS to be in the range of $0.65 to $0.70 versus the previous range of $0.50 to $0.60. We continue to estimate SG&A will be in the $180 million range based on the current run rate. And even though we had a tax benefit this quarter, we continue to see the full tax year expense in the $12 million to $13 million range. This implies a higher tax expense clearly in Q4.

We are pleased with the results along with earnings and cash conversion in this very difficult environment but we are trying to remain cautious. In Europe, we are watching the commercial vehicle market closely and we are doing the same in South America. We have one more quarter to go before we can close out a very solid year and we are in the middle of our fiscal 2015 planning process. Once both of those are complete we will be back to give you more perspective on the new fiscal year.

With that, Tom, I will turn it back to you.

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

Our European team continues to improve the manufacturing processes and are impacting margins on our truck program launches in the region and we will be focused on the consolidation of our German manufacturing footprint which will be the final phase of our restructuring program.

Our Airedale business is up and running at their temporary facilities and continues to fill their order book despite the longer lead times.

As Mick mentioned, it is great to see the business converting the increase in sales at such a strong great. Given the current strength of our balance sheet, we are in a position to evaluate options for growth and we are doing just that. We hope to close on the Barkell acquisition in the fourth quarter and we will report on other initiatives as they develop.

With that, we will take your questions.

(Operator Instructions). Mike Shlisky, JPMorgan.

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

In the guidance range we just gave, so the $0.65 to $0.70, that includes the tax benefit so all taxes are in are a net number.

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

First off in China, we are really pleased to see the market come back on the off-highway business which is a very important footprint we have now. In addition, we have the oil cooler business that is coming online and launching and is really strong in the next fiscal year. That is about 2.8 million oil coolers that will be launching over a period of time that is really going to help diversify that business.

In addition to your question, we are really looking to diversifying the business and look at opportunities to push into commercial truck business and so on. We obviously have landed some business already and we seek clear opportunities for more. So this will be -- all of our areas are aggressively pushing for growth but clearly Asia has great opportunity and we are pushing that heavily.

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

Sequential. That is going to be a sequential increase. Obviously we saw a tough third-quarter for us -- calendar fourth-quarter for the reasons I mentioned on a year-over-year basis but we are starting to see as they came back from the extended shutdown, strength of orders coming back in place both on the aftermarket side, our commercial customers, commercial vehicle customers are talking about strengthening through the year coming out in the new calendar year so we anticipate that 0% to 5% increase on the commercial vehicle side in growth.

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

I think the best way to describe it is we have had some downtime or orders cut from our ag customers. So that is really the best way to describe it. Obviously a year ago at this time, ag was running very strong so this was some of the first signs of market weakness we have seen in the past quarter. So with commodity prices as they are, anticipating the fact that that is probably going to continue onward, I think it is going to be a challenging year for ag in North America.

Okay, great, guys. Thank you so much.

David Leiker, Baird.

Good morning, everyone. A couple of things. Start with Europe here first off. You are a month into the first calendar quarter, any insight you can give us in terms of how much downtime your customers are taking as we go through this transition from Euro 5 to Euro 6?

What we are seeing, David, right now is we saw some extended downtime taken around the holidays and the volume, they are actually reducing releases and pushing them out, they are not saying they are coming out, they are just pushing the orders out so they ramp up rate that was projected as the slope is decreasing but they are not taking orders out. So we are kind of snowplowing it forward.

We have not seen direct downtime although we have heard speculation that there may be some downtime coming up but we have not seen any yet.

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

Yes, so well, I think we said of the increase in commercial truck over the last quarter, about a quarter of that was the increase in Euro 5 because of that pre-by effect but we are seeing increases. The ramp up is happening just not at the rate that we talked about. So Euro 6 volumes are coming, they are just at a reduced level and again plowing that forward.

But we are ramping up to a level that is probably somewhere in the -- something less than -- maybe 50%, 75% of what projected volumes were going to be at this time. But they are not pulling -- the key point is we are not pulling the orders, we are pushing them out.

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

No, not yet.

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

Well, it is a snowplow effect to see if it keeps going through the quarter. Right now they are pushing them into the next quarter from what we've seen this quarter so we are assuming that some of that is going to come true. How much is going to be the question.

So that is a pretty good indicator from what we have. We are close to our customers and clearly watching this because filling the pipeline for them is very important so they are not taking their foot off the pedal at all. They are just kind of saying -- they are just pushing them out.

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

We would be quite happy with a 25% type conversion on incremental volume, David.

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

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

And so it is going to be again, it is going to be delivered right on top of all of the other things that we have committed in that region they have delivered on them both on SG&A reductions, asset reductions and consolidation of the tech center and this is the last peg we have got to put into the system here to tie down the [structurings] so I'm very pleased with it.

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

The team has done a great job.

What facility are you consolidating into?

I would rather not give specifics at this point but it is an existing facility in the German local network and we are, again, it is a good move overall as far as it gives us a little more flexibility of things we need to do because of the size of the facility and it is a very good workforce that has been established there. So we are very pleased.

Okay, great. Thank you very much.

(Operator Instructions). Walter Liptak, Global Hunter.

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

Obviously any transfer of production is a critical transfer and it is going to be an aluminum product consolidation and which we have two aluminum plants that both do what we would call powertrain cooling product both in off-highway and in automotive or consolidating those one, will be a lot of synergy because of that. But we are carefully, carefully designing this to make sure there is no risk of interruption and that is why the 18 months projection of timing of getting it done is so important. So it will be be -- by the end of this we will have a very much higher consolidated higher synergistic footprint with higher scale in the manufacturing and we are just manufacturing overhead.

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

Well, the majority of our sales in the heating business is replacement business going into greenhouses, industrial warehouses and the like, and large garage facilities and that type of thing. So by far there has been a big replacement market. Clearly the weather is driving that.

But I think this is kind of years in the making again. Our teams have come out and put leading product out there from an efficiency standpoint, reliability standpoint and I think -- I can't give enough credit to our distribution network and manufacturing facilities that are able to respond in short-term orders. A lot of times when you have a replacement business that go with the replacement they need it on time and that large installed base that we have out there works to our advantage. So this is one of those times when we took the weather and it lined up well with pushing demand and we are able to cash in on it.

And the demand is continuing into January?

Yes, we have seen strong demand through January thus far and that is great for us because typically we start stocking -- we are stocking with our distributors in March and we are going to be pushing into that pretty soon. We think it is going to go right into February from the outlook so it has been a great season.

Okay, great. Thank you.

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

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

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